The highly-anticipated changes to the Franchising Code of Conduct (‘the Code’) are now in force.
These changes follow a parliamentary inquiry into the Code, which began in 2018. The inquiry saw many franchisees explain how their franchised business failed, and the consequences on their lives. It also exposed questionable business strategies by some franchisors, and has directly led to at least one enforcement action by the Australian Competition and Consumer Commission (‘ACCC’).
It is important for both franchisors and franchisees to understand that significant changes to the Code are now in force – many of which involve imposing civil penalties for breach.
Below is a summary of five core areas that have seen significant change.
Please note, this is not a complete explanation of all the changes, and some of the changes only apply to franchise agreements entered into, or disputes that arise on, or after 1 July 2021.
The disclosure document is becoming more detailed. From 1 November 2021, franchisors must provide new information, including:
- The percentage of franchisees in the system who were party to an alternative dispute resolution (ADR) process in the last 12 months.
- Where applicable, details of certain rebates that franchisors receive from suppliers.
- Where a franchisee occupies premises which are leased by the franchisor or its associates, the franchisor must provide details of any lease incentives.
NB. Both this and the rebate information requirement are likely to have a significant impact on franchisors who may need to evaluate their supply and/or leasing practices.
- Further detail surrounding the consequences of termination, including what happens to unsold stock and whether the franchisee acquires any goodwill in the business.
Franchisors must also create and maintain a ‘Key Facts Sheet’, which is essentially a condensed version of the disclosure document. This Key Facts Sheet must utilise the form specified by the ACCC, and must be given to franchisees before the mandatory 14 day signing period begins.
The Code now prohibits a franchisee from undertaking ‘significant capital expenditure’ during the term of the agreement. However, there are exceptions - being where the expenditure:
- is disclosed to the franchisee in the disclosure document;
- is to be incurred by all, or a majority of franchisees - and a majority of those agree to it;
- is required to comply with the law; or
- is agreed by the franchisee.
Franchisors looking to rely on the first exception must provide their franchisee/s with ‘as much information as practicable about the expenditure’, including the anticipated timing and cost, the expected risks and the rationale for it. To avoid liability for misleading or deceptive conduct, franchisors will need to ensure that any projections are made on reasonable grounds.
Franchisors will frequently pass on the costs of preparing the franchise agreement to the franchisee. It is also common for franchise agreements to provide that franchisees must pay the franchisor’s costs of issuing other documents, such as a breach notice.
However, the Code now limits franchisors passing on the costs of preparing the agreement, unless the agreement states:
- the specific amount payable;
- that the amount relates to the franchisor’s legal costs of preparing, negotiating or executing the agreement; and
- that the amount does not include ‘any amount for the franchisor’s costs of legal services that will or may be provided, after the agreement is entered into, in relation to preparing, negotiating or executing other documents’.
This effectively prohibits franchisors from recovering costs for issuing breach notices, or potentially other documents that often accompany a franchise agreement (e.g. personal guarantees or security interests).
The cooling off period has been extended from 7 days to 14 days. In addition, the cooling off period will begin at different times depending on the circumstances.
If the franchisee is relying on the franchisor for an occupancy right, the cooling off period does not begin until the franchisee receives the lease proposal and/or lease. If the franchisee receives a lease proposal, but the lease is not ‘substantially identical’ to the proposal, the franchisee can cool off within 14 days of the lease beginning.
This change will significantly impact the process of franchisors entering into leases and, together with the requirement to disclose incentives, could lead franchisors to be more inclined to allow franchisees to hold the lease.
If a franchisee is selling their franchise, and the new franchisee inherits their agreement rather than signing a new one, the cooling off period can potentially end well after the sale has completed.
This means the new franchisee can sign a deed of assignment, pay the sale price, and then exercise their cooling off rights before starting (in which case the seller has to refund the sale price and becomes the franchisee again).
While most franchisors will insist on the new franchisee signing up to a new agreement, this could have a significant impact for the way franchise sales are structured.
Another change is that franchisees are now given the express right to request an early termination of a franchise agreement. Whilst franchisors are not required to accept the request, they must at the very least:
- give a ‘substantive written response’ to the request within 28 days; and
- if the request is refused, provide reasons.
It is also important to note that immediate termination for ‘special circumstances’ no longer exists. Instead, franchisors must give 7 days’ notice if they intend to terminate for ‘special circumstances’ (and only then if they are specified in the agreement).
The franchisee will then have the opportunity to raise a formal dispute, which will effectively pause the termination for at least 28 days and until the mandatory part of the dispute resolution process is completed (see further below).
However, as long as the franchise agreement provides for it, franchisors may prevent the franchisee from operating the franchise in the interim. Franchisors will of course need to consider the application of the good faith obligation when exercising this right.
- The Code now refers to an ‘ADR process’ – being mediation and conciliation – rather than just mediation. This is a subtle but potentially significant change;
- Further, if a franchisor and franchisee have a dispute, they can agree to have it resolved by arbitration. This is a significant change which would result in binding decisions away from the courts;
- Multi-franchisee mediation is now possible - meaning if two or more franchisees have similar disputes, they can:
- discuss their disputes without being in breach of any confidentiality obligations in their franchise agreements; and
- refer their disputes to a single mediation/conciliation.
Franchisors must update both their franchise agreements and disclosure documents, and add the key facts sheet to the suite as soon as possible. If you’re unsure of your requirements, get in touch with Holman Webb’s Franchising & Retail Group, who can assist with all steps in this process.
Franchisors must also significantly change some operational matters, for example:
- procedures surrounding immediate termination;
- issue of leases;
- costs of preparing documents; and
- how requests for early termination are handled.
Franchisors will also need to consider whether changes are needed to their arrangements with third parties. For example - landlords and/or network suppliers generally want lease/supply incentives to be kept confidential, but the changes to the Code require them to be disclosed to franchisees in some circumstances.
Franchisees must also become familiar with the changes to ensure that they are receiving the information they are entitled to.
Franchisees selling their business should pay particular attention to the cooling off period that now applies to them, as well as the goodwill section of the disclosure document. Franchisees will now have more information than ever when entering into a franchise agreement, and they should use it to make an informed choice before entering into a franchise.
If you have a query relating to any of the information in this article, or you would like to discuss how these changes to the Franchising Code of Conduct are set to impact your business, please get in touch with Holman Webb’s Franchising & Retail Group today.