Franchise agreements and ‘unfair’ contract terms – increased risk for franchisors
Franchise agreements and ‘unfair’ contract terms – increased risk for franchisors

Key points:

  • Previously, an ‘unfair’ contract term could be declared void. However, from 9 November 2023, franchisors are prohibited from entering into standard form contracts with franchisees that contain unfair terms.
  • Franchisors are also prohibited from relying on unfair terms, which have been renewed or varied on or after 9 November 2023.  
  • Doing so may attract substantial financial court penalties, now potentially in the millions.

Which contracts do the unfair terms regime apply to?

The unfair contract term protections cover small business standard form contracts.

A ‘standard form contract’ is not defined in the legislation, but factors include whether the contract was prepared before any discussion and whether there was an opportunity to negotiate its terms. In other words, a contract that already exists and is offered on a ‘take it or leave it’ basis or close to it is likely to be a ‘standard form’ contract.

The ACCC considers that it is likely that many franchise agreements are standard form contracts, though it will depend on the circumstances.

A ‘small business’ is now defined as a business that either employs less than 100 people or has an annual turnover of less than $10 million. Therefore, a large proportion of franchisees and master franchisees are likely to be deemed to be a ‘small business’ and protected under the unfair contract terms regime.

When is a term in a standard form contract unfair?

The test for whether a term in a standard form contract is unfair has not changed after the reforms. The test is contained in the Australian Consumer Law (ACL), which says a term will be unfair if:

  • it causes a significant imbalance in the rights and obligations of the parties;
  • is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by such a term; and
  • it would cause detriment to a party if the term were to be applied or relied on.

Potentially ‘unfair’ terms in franchise agreements

In its recent report on unfair terms in franchising, the ACCC reviewed ten franchise systems from small to mid sized networks. From that review, it identified several franchise agreement clauses that may be ‘unfair’. Many of these clauses are common across franchise agreements in many different industries.  

The ACCC identified the following areas as problematic:

  1. Unilateral variation

Unilateral variation refers to one party (generally the franchisor) being allowed to vary the contract without the other party's consent.

The ACCC expressed concerns about clauses that give the franchisor the sole or absolute discretion to change the agreement and the franchisee has a very short period to implement the change. In franchising, this often arises where an operations manual is deemed to be part of the franchise agreement and the franchisee must comply with any changes to it within a matter of weeks. In some cases, this might be reasonable, for example, if a safer way of performing a task is identified. But in other cases, particularly those that require franchisees to take on additional expenses, it may be unfair.

  1. One-sided withholding or setting off payments

A clause that allows the franchisor to withhold or set off payments without giving the franchisee the same rights was identified by the ACCC as potentially unfair.

Examples of when such a clause may create issues include:

  • when the franchisor can withhold payments or set-off in any circumstance; or
  • when the franchisor does not need to notify the franchisee about the set-off or withholding of payments.

While there may be reasons of convenience to allow a franchisor to set off amounts owing to a franchisee, a one-sided, absolute right without qualification could certainly be an ‘unfair’ term.

  1. Auditing the franchisee

An audit clause allows the franchisor to audit the franchisee’s business. Generally audit clauses may do the following:

  • give the franchisor broad discretion to audit the franchisee, usually without giving the franchisee reasonable prior notice;
  • if there is a discrepancy identified in the audit, the franchisee is required to pay the franchisor the underpayment;
  • in some cases, the franchisee is required to pay the franchisor for expenses incurred in the audit.

There can be legitimate reasons for such clauses. However, they may be unfair:

  • when the franchisee is required to pay interest on an underpayment at a higher default interest rate than what would apply in the normal course of business; or
  • when the franchisee is required to cover all costs related to the audit without limits and there is no express obligation for the franchisor to keep the costs reasonable.
  1. Restraint of trade

A restraint of trade clause typically restricts franchisees from operating a similar business after the agreement comes to an end.

Concerning restraint of trade clauses include:

  • the capture of acts such as ‘participating in’, ‘interested in’, or ‘indirectly involved with’ in the definition of restricted conduct;
  • cascading clauses which include an excessively wide range of restraint periods e.g. 5 years to 3 months and/or restraint areas e.g. 2 kilometres from the relevant area to the entire country.

Excessive cascading clauses create uncertainty for franchisees about the extent to which they are restricted. While there may be valid reasons for restraining a franchisee after the end of the franchise, and a cascading clause can be an effective and fair way of protecting the network, any restraint that is unreasonable and goes beyond protecting the franchisor’s legitimate business interests is likely to be unfair (and unlikely to be enforceable anyway).

  1. Termination

The ACCC considers that in the franchising relationship, franchisees are subject to a substantial risk of loss if the agreement is terminated. That is reflected in the restrictions on franchisors under the Franchising Code of Conduct (Code). Accordingly, termination should never be taken lightly or rushed.

Termination clauses identified by the ACCC that may be unfair include:

  • where the franchisee is not given the same balance of rights to terminate the agreement if the franchisor breaches the agreement and fails to remedy the breach. A significant number of franchise agreements would fall into this category - it is typical for franchise agreements not to give franchisees an express right to terminate; and
  • giving the franchisor the right to terminate the agreement without the franchisee’s consent and before expiry even if the franchisee had not breached the agreement. While the ACCC noted that it was particularly concerned about such a clause, it is not clear what if any impact clause 28 of the Code (which allows franchisors to terminate in certain circumstances without any breach by the franchisee) has on this.

Next steps

From 2016, when the unfair terms regime began applying to small business contracts, franchisors should have ensured that a full review of their agreements had been conducted. The increased penalties make that even more important. Not only that, but the ACCC has already acted against franchisors on this issue and has stated that it is a priority area for them moving forward.

If a franchisor is concerned that its standard form agreements contain any potentially unfair terms, immediate steps should be taken to mitigate against the increased risk.

If you have any questions about this article or need assistance with ensuring compliance with the new unfair contract term reforms, please do not hesitate to contact Daniel Jepson, Tal Williams, Ann Kwak or speak with a member of the Business, Corporate & Commercial Team

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