Australia: Changes to the Franchising Code of Conduct – Part 2

Last Updated: 24 September 2013
Article by Racha Abboud

Earlier this month we reviewed the first five recommendations Mr Alan Wein made to changes to the Franchising Code of Conduct. In this article, we have looked at the next four recommendations, six to nine.

Recommendation 6(a)

The Code be amended to provide franchisees and franchisors with a right to terminate the franchise agreement in the event that any administrator of the other party does not turn the business around, or a new buyer is not found for the franchise system, within a reasonable time after the appointment of an administrator. It should be made possible for the courts to make an order extending the timeframe in appropriate cases. It should also be clear that the parties can negotiate a right to terminate at an earlier stage.

Whilst the Government has agreed to this in principle, they have noted that it raises a number of unintended consequences including the ability of a franchisor and franchisee to obtain financial credit in the longer term. Most franchise agreements currently contain a right for a franchisor to terminate a franchise agreement in the event of a franchisee becoming insolvent. The same right is not normally afforded to the franchisee. The Government has noted that this could be dealt with by providing franchisees with a reciprocal right. However careful consideration needs to be given to whether any franchisee will in fact try and end their franchise agreement when a franchisor enters into administration as often enough if a franchisor has entered into administration the business is either turned around or a buyer is found for the franchise system. Whilst this could take some time to occur, having the franchise agreement remain on foot has more value to the franchisee in those circumstances then if they had the right to terminate it.

Recommendation 6(b)

The Code be amended to ensure the franchisees can be made unsecured creditors of the franchisor by notionally apportioning the franchise fee across the term of the franchise agreement, so that any amount referable to the unexpired portion of the franchise agreement would become a debt in the event that the franchise agreement ended due to the franchisor's failure.

This raises a number of concerns for a franchisor should the recommendation be adopted. The main concern being that an initial franchise fee whilst it may appear to be for the term of the franchise, the fee is in fact a start up payment made by franchisees for the system, the intellectual property and franchisor brand. Depending on the franchise system, franchisors will charge fees under the banner of royalties or even a franchise service fee. If the Government was to adopt this recommendation, it would mean that a franchisor in the event of it becoming insolvent would have to include the apportioned franchise fee in the total monies owing to its creditors, which probably includes its franchisees.

Recommendation 7

The Code be amended to prohibit franchisors from imposing unreasonable significant unforeseen capital expenditure. 'Unreasonable' and 'significant' should be defined, with a view to a franchisor being able to demonstrate a business case for capital investment in the franchised business.

The last Code review imposed an obligation on a franchisor to specify in its disclosure document 'unforeseen' capital expenditure. This caused much confusion amongst the franchising industry as by their very nature and meaning it was close to impossible for franchisors to list 'unforeseen' expenditures that franchisees would be up for. This forced many franchisors to provide a comprehensive list of expenses causing confusion to their franchisees. The Government has now indicated that they will remove these requirements from the Code and in line with the recommendation include an obligation on franchisors to provide common examples of potential unforeseen capital expenses. The great obligation that would be imposed on franchisors is centered around a franchisor having to demonstrate that the significant capital expenditure is reasonable despite it not being disclosed in the disclosure document or franchise agreement.

Recommendation 8

The Code be amended with respect to the administration of marketing funds, namely:

  • franchisor should separately account for marketing and advertising costs;
  • contributions from individual franchisees should be held in trust for franchisees, with the franchisor having a wide discretion as to how to expend the funds;
  • company owned units must contribute to the funds;
  • the marketing and advertising fund should only be used for expenses which are clearly disclosed to franchisees in the disclosure document and which are legitimate expenses;
  • a yearly audit should be mandatory if the fund exceeds a certain threshold with no capacity for franchisees to vote against the audit, and
  • the result of the audit and results of the expenditure of the fund should be made to franchisees yearly.

Currently the Code under clause 17 provides that franchisors are required to detail all of the marketing funds receipts and payments and to provide an automatic entitlement to franchisees to receive the financial statement within 30 days of preparation. Whilst the Government has only accepted this recommendation in part, the extra obligation that it wishes to impose on franchisors to disclose in their disclosure document what marketing and advertising expenses are and to account for each expenditure separately may mean that there will be additional compliance obligations on the franchisor and may complicate and increase the size of an already lengthy disclosure document.

Recommendation 9

The Code be amended to include an express obligation to act in good faith. The obligation should:

  • extend to the negotiation of a franchise agreement, the performance of the parties and the resolution of any disputes;
  • incorporate the unwritten law relating to good faith similar to the unconscionable conduct prohibitions set out in the Australia Consumer Law;
  • apply to both franchisor and franchisee;
  • not be excluded or prohibited in the franchise agreement;
  • clear state that they are not intended to stop a party from acting in its own commercial interest, and
  • exclude an argument that the franchisor has not acted in good faith because there is no term in the agreement specifying a right of renewal.

The Government is concerned to ensure that this does not create confusion within the sector, as mere reference in the Code to the unwritten law is likely to make it difficult for parties without legal representation to understand exactly what is being asked of them. They do however agree that good faith does not apply to all aspects of the franchise deal or the Code. Further consultation is to take place with key stakeholders, and the Government will provide guidance in due course. The ACCC has also been asked to provide education on this.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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