Franchising Code changes should have minimal practical impact

11 June 2010

Introduction

The Federal Government has moved quickly to implement its response to the recent parliamentary inquiries concerning franchising and unconscionable conduct, with amendments to the Franchising Code of Conduct (Code) to take effect from 1 July 2010. For most franchisors there will be minimal impact and the changes to the disclosure document will be able to be made as part of the normal annual update of the disclosure document.

There are no transitional arrangements, so any franchisee that signs a franchise agreement on or after July 1 2010 must have received a disclosure document that complies with the amended Code. As the normal four month grace period will not apply, franchisors actively granting new franchises will need to move quickly to update their documents. In limited circumstances where a disclosure document has already been provided, there will be a need to re-disclose.

The Government had previously flagged the nature of the amendments, with most being procedural or clarifying existing drafting ambiguity, referencing or formatting. The new requirements that have an impact on the content of the disclosure document or the operational practices of franchise systems are as follows:-

Franchising Code of Conduct clauses

1. New clause 20A - End of term arrangements. If the term of a franchise agreement is six months or longer, the franchisor must notify the franchisee, at least six months before the end of the term of the franchise agreement, of the franchisor’s decision to renew or not to renew the franchise agreement or enter into a new franchise agreement. If the term is less than six months, the notice period is one month.
   
   Comment: The intent was to catch end of term arrangements only, but the drafting is not ideal. Apart from the apparent oversight that the notice does not have to be in writing, this requirement would appear to also catch normal renewals on exercise of an option. To some extent this will depend on the wording of each franchise agreement, and whether “term” is defined to include options. However a conservative approach, which ought not cause too many problems, would be for the franchisor to give notice of its decision at least six months out in the case of option renewals. There is no prohibition on the decision being conditional, so it can be subject to the franchisee satisfying any normal pre-conditions to renewal as set out in the franchise agreement. There is also no outer limit of when notice can be given, although the ACCC is likely to adopt a common sense interpretation to ensure compliance with the intent of the clause.
   
   Franchisors should check their records to ensure they have indexed the expiry dates of all of their franchise agreements, so that notice can be given at the appropriate time.
2. The Government rejected calls to include a statutory good faith obligation, but included a new clause 23A noting that nothing in the Code limits any obligation imposed by the common law, applicable in a State or Territory, on the parties to a franchise agreement to act in good faith.
   
   Comment: This was a very sensible decision. The new clause recognises that a duty of good faith and fair dealing will be implied into many franchise agreements, but that this is not automatic and will depend on the relevant circumstances of each particular case.
3. New clauses 29(8) and 31.4 - Mediation. The legislation attempts to create some additional guidelines to improve the conduct of parties during mediation. The existing requirement for the parties to “attend the mediation and try to resolve the dispute” is supplemented by provisions which note that a party will be taken to be trying to resolve a dispute if the party approaches the resolution of the dispute in “a reconciliatory manner”. Illustrations of what would be reconciliatory include attending and participating in meetings at reasonable times, making what you are intending to achieve in mediating clear at the beginning of the mediation process, observing any obligations relating to confidentiality that apply during or after the mediation process, not taking action which has the effect of damaging the reputation of the franchise (such as providing inferior goods, services, or support) during the dispute, and not refusing to take action that would have the effect of damaging the reputation of the franchise system during the dispute.
   
   There is also a new definition of “the costs of mediation” to specifically include the costs of the mediator, room hire and any additional input (including expert reports) agreed by both parties to be necessary to the conduct of the mediation.
   
   Comment: The amendments appear not to add any new substantial legal requirement, and in practice are more likely to be of concern to franchisees than franchisors. One could take issue with the need for such additional wording, but the intent appears to be to encourage parties to embrace the spirit of mediation and address public criticism about the effectiveness of mediation in all circumstances.

Disclosure Document – Annexure 1

4. There is an additional sentence to be included in the preamble to the disclosure document requiring franchisors to note as follows: Franchising is a business and, like any business, the franchise (or franchisor) could fail during the franchise term. This could have consequences for the franchisee.
   
   Comment: This new requirement is straight forward. According to the Government the wording is intended to address concerns expressed during the franchising inquiries that franchisees may not be aware of the possible consequences if a franchisor or a franchise system fails.
5. A new clause 13.6A is to be inserted in the disclosure document requiring the franchisor to list each recurring or isolated payment, that is within the knowledge or control of the franchisor or is reasonably foreseeable by the franchisor, that is payable by the franchisee to a person other than the franchisor or an associate of the franchisor. Franchisors must then provide a description of the payment, the amount of the payment or formula used to work it out, to whom the payment is made, when the payment is due and whether the payment is refundable and, if so, under what conditions.
   
   Comment: The intent is to supplement clause 13.6, which is limited to payments to the franchisor or an associate, to catch third party payments. However, the wording is less than ideal. Presumably the new clause is not intended to cut across the existing requirements regarding payments to agents in paragraph 5.1 of Annexure 1.
6. A new clause 13A is to be inserted in the disclosure document in relation to unforeseen significant capital expenditure. Franchisors must advise whether the franchisor will require the franchisee, through the franchise agreement, the operations manual (or equivalent), or any other means, to undertake unforeseen significant capital expenditure that was not disclosed by the franchisor before the franchisee entered into the franchise agreement.
   
   Comment: This requirement is presumably intended to require disclosure of any capital expenditure during the term, to ensure franchisees do not think the only capital expenditure they will need to make is on signing. Refurbishment of premises, and investments in point of sale or other equipment, are examples of expenditure that might prudently be disclosed under this section.
7. A new clause 13B is to be inserted in the disclosure document requiring a franchisor to disclose whether, in a dispute, the franchisor will attribute the franchisor’s costs, including legal costs, incurred in dispute resolution, to the franchisee.
   
   Comment: This would seem to require a fairly simple yes or no answer. The Franchise Council of Australia suggested that the Government consider whether the Code should prohibit franchisors from recovering the franchisor’s costs of attending mediation, as this was contrary to the spirit of the Code, but this suggestion was not adopted.
8. A new clause 17A is to be inserted in the disclosure document requiring a franchisor to disclose the circumstances in which the franchisor has unilaterally varied a franchise agreement in the past. If a franchise agreement is entered into in a financial year commencing on 1 July 2011, 1 July 2012 or 1 July 2013 — disclosure is required for the period since 1 July 2010. For a franchise agreement entered into in a financial year commencing after 1 July 2013 the details need to be provided for the past three years. Franchisors must also disclose the circumstances in which the franchise agreement may be varied, unilaterally, by the franchisor in the future.
   
   Comment: Most franchisors do not unilaterally vary franchise agreements, but care needs to be taken in relation to changes to the manual. These changes in many cases are deemed to be changes to the franchise agreement. Similarly a requirement for a franchisee to sign ‘the then current franchise agreement” may also need to be disclosed. Franchisors should seek legal advice on wording appropriate to their system, but compliance ought not to be particularly complex in most instances.
9. A new clause 17B is to be inserted in the disclosure document requiring franchisors to disclose whether a confidentiality obligation will be imposed by the franchisor on the franchisee. If so, details of the matters that the obligation may cover must be disclosed, including the outcomes of mediation, settlements, intellectual property, trade secrets and particular aspects of individual agreements, such as fees.
   
   Comment: Franchisors will need to seek legal advice to obtain appropriate wording for their individual circumstances. However, compliance should not be difficult.
10. A new clause 17C is to be inserted in the disclosure document requiring franchisors to detail the process that will apply in determining arrangements to apply at the end of the franchise agreement, including whether the prospective franchisee will have any options to renew or extend the franchise agreement or enter into a new franchise agreement. If so, the franchisor must describe the processes that it will use to determine whether to renew or extend the franchise agreement, and whether the prospective franchisee will be entitled to an exit payment at the end of the franchise agreement. If so, franchisors must explain how the exit payment will be determined or earned.
    
    Details must also be provided of the arrangements that will apply to unsold stock, marketing material, equipment and other assets purchased when the franchise agreement was entered into, including whether the franchisor will purchase the stock, marketing material, equipment and other assets. If a purchase is to occur there must be disclosure of how prices will be determined, and whether the prospective franchisee will have the right to sell the business at the end of the franchise agreement.
    
    If the prospective franchisee will have the right to sell the business at the end of the franchise agreement the disclosure document will need to specify whether the franchisor will have first right of refusal, and how market value will be determined, and whether the franchisor will consider any significant capital expenditure undertaken by the franchisee during the franchise agreement in determining the arrangements to apply at the end of the franchise agreement.
    
    Comment: This is probably the most complex of the new Code requirements, but compliance should still be relatively straight forward. The intent is to highlight for prospective franchisees what, if anything, happens at end of term. In most current franchise agreements the legal answer to that question is that all rights cease, but the Government felt that this may not always be understood by franchisees. The Government accepted the submission by the Franchise Council of Australia and has not imposed any obligations to compensate or purchase assets, but wishes to highlight the issue and ensure there can be no uncertainty.
    It is important to note that this clause is also linked to the notice requirements for end of term arrangements discussed in paragraph 1 above.
11. There is a new requirement for franchisors to provide a rolling table that sets out whether a franchisor takes into consideration any significant capital expenditure in determining the arrangements to apply at the end of franchise agreements. If a franchise agreement is entered into in a financial year commencing on 1 July 2011, 1 July 2012 or 1 July 2013 — disclosure is required for the period since 1 July 2010. For a franchise agreement entered into in a financial year commencing after 1 July 2013 the details need to be provided for the past three years.
    
    Comment: The wording of this amendment is a little unclear, but is intended to address situations where franchisors require more capital expenditure by the franchisee before considering whether or not to grant an extension of the franchise, or whether such expenditure would influence the decision. Franchisors will need to seek legal advice to obtain appropriate wording for their individual circumstances. However compliance should not be difficult, and in most cases the answer is probably simply “no”.
12. A new clause 17D is to be inserted in the disclosure document requiring franchisors to detail whether the franchisor will amend (or require the amendment of) the franchise agreement on or before the transfer or novation of the franchise.
    
    Comment: This requirement is relatively straight forward. Although not explicitly stated, it would be prudent to disclose any requirement for the incoming franchisee to sign the then current franchise agreement or an agreement that differs from that of the transferor franchisee.
13. Similar amendments are required in relation to the Annexure 2 short form disclosure document.

In summary, the amendments to the Code are likely to be largely non-contentious and should provide additional disclosure to franchisees in the areas of end of term arrangements, future capital expenditure requirements and unilateral contract variation in a manner which is pragmatic and cost-effective. The Government is to be commended for the timing, which will minimise the compliance cost for most franchise systems.