The Australian Government has released for public consultation an exposure draft of amendments to the Franchising Code of Conduct (Code) and relevant provisions of the Competition and Consumer Act 2010 (Cth) (CCA).
The reforms are likely to have a significant impact on the franchising sector if implemented and raise the bar significantly for franchisors. The proposed amendments, if passed, will create much more severe consequences for franchisors associated with a breach of the Code.
Interested parties will have an opportunity to make submissions on the draft legislation and regulations up until 30 April 2014 and it remains to be seen whether there will be any significant modifications to the current proposals.
When will the proposed changes take effect?
The proposed new Code, and the amendments to the CCA, is intended to take effect from 1 January 2015. The new Code will apply to a franchise agreement entered into on or after 1 January 2015 or renewed on or after 1 January 2015. In this update, we will focus on the following major aspects of the proposed reforms:
- new statutory obligation to act in good faith
- new civil penalties for breach of the Code
- new power for the Australian Competition and Consumer Commission (ACCC) to issue infringement notices under the CCA
- key changes to the Code.
Proposed new statutory good faith obligation
A new obligation to act in good faith has been inserted in the proposed new Code. This includes an obligation to act honestly and not arbitrarily and to co-operate to achieve the purposes of the franchise agreement.
The proposed new obligation requires each party to a franchise agreement to act towards another party with good faith in respect of any matter arising under or in relation to the franchise agreement or the Code. The good faith obligation also applies to prospective franchisees in respect of:
- any dealing or dispute relating to a proposed agreement with a prospective franchisee
- the negotiations of a proposed agreement
- the Code.
However, the obligation is expressed not to prevent a person from acting in his or her legitimate commercial interests and does not require a franchisor to include a clause in a franchise agreement allowing a franchisee to seek renewal of their franchise agreement.
The statutory obligation to act in good faith does not limit or displace the common law of good faith and so is an additional obligation. The introduction of a statutory definition of good faith was not contemplated in the Wein Report which was released in 2013.
It remains to be seen how the Courts might interpret this new obligation. The proposed new statutory duty to act in good faith could impact on a wide range of decisions associated with franchising including:
- unilateral variations to franchise agreements
- decisions not to enter a franchise agreement with a prospective franchisee
- decisions not to renew a franchise agreement
- the negotiation of terms of a franchise agreement
- the negotiation of renewal of a franchise agreement
- a decision not to agree to a transfer of a franchise
- decisions taken in relation to the supply of goods or services to franchisees
- termination of franchises
- disputes over the interpretation of franchise agreements.
This proposed new obligation will be in addition to other existing legal obligations, such as those relating to unconscionable conduct and misleading and deceptive conduct. In our view, the introduction of this type of obligation is likely to result in significant uncertainty for franchisors. It will be beneficial to see any further guidance the ACCC may give as to how it intends to interpret the proposed new obligation in practice.
Proposed new civil penalties
It was established in the decision of the High Court in Master Education Services Pty Ltd v Ketchell (2008) 236 CLR 101 that the Courts had the power to take a flexible approach in relation to breaches of the Code. In particular, a Court could prevent entry into a franchise agreement, vary the terms of an agreement entered into in breach of the Code, order the termination of such an agreement or provide compensation for loss and damage if it is shown to have been caused by the contravention.
In addition to these potential sanctions, it has been proposed to introduce new civil penalties for breaches of the Code. For example, the updated Code will continue to require a franchisor to give a franchisee:
- a copy of the Code
- a disclosure document in the required form
- a copy of the franchise agreement in the form in which it is to be executed,
at least 14 days before the franchisee:
- enters into, renews, extends, or extends the scope of, the franchise agreement
- pays a non-refundable deposit in relation to the proposed franchise agreement,
(14 Day Period Requirements).
Under the new Code, failure to comply with the 14 Day Period Requirements may attract a civil penalty of up to 300 penalty units (currently $51,000).
Breaches of other provisions of the Code will also attract the same civil penalty. These include the obligations to:
- give franchisees a copy of a lease where the franchisee leases premises from the franchisor or an associate and the obligation to give details of any incentive or financial benefit the franchisor is entitled to receive within 1 month after the lease or agreement to lease is signed
- give franchisees a copy of other agreements such as a lease or hire purchase agreement, an agreement under which the franchisee gains ownership of or is authorised to use any intellectual property, a security agreement including a guarantee, mortgage, security deposit, indemnity, loan agreement or obligations to provide a bank guarantee, a confidentiality agreement or an agreement not to carry on business within an area or for a time after the franchise agreement is terminated
- provide copies of financial statements for a marketing or cooperative fund
- repay all payments (other than amounts permitted to be retained) within 14 days where a franchisee has terminated an agreement during the 7 day cooling off period.
Termination by a franchisor in breach of the Code will also attract the same civil penalty as will:
- doing or omitting to do anything with the intention of influencing a former franchisee to make a request that their details not be disclosed to a prospective franchisee
- making an inducement to a franchisee or a prospective franchisee that will impair their freedom to form an association with other franchisees
- failure to provide a disclosure document upon written request within the required timeframe
- failure to make disclosure of materially relevant facts within a reasonable time
- failure to notify the franchisee in writing whether the franchisor intends to renew the agreement or enter a new agreement at least 6 months or more before the end of the term (if the term is for at least 6 months)
- failure to attend a mediation provided for pursuant to the Code.
A new section 51AAAC is proposed to be inserted into the CCA which will give the ACCC the power to issue infringement notices (Notice) for an alleged contravention of the Code. A Notice can be issued by the ACCC where the ACCC has reasonable grounds to believe that a person has contravened a civil penalty provision of the Code. The Notice is to be issued within 12 months of the day that the contravention of the civil penalty provision is alleged to have occurred and a Notice must not be issued for the same alleged contravention of the Code.
The amount of the penalty will be 50 penalty units ($8,500) for companies. If there is compliance with a Notice and payment of the penalty:
- this will not be regarded as an admission of contravention of a civil penalty provision of the Code
- no proceedings (whether criminal or civil) may be started or continued against a person in relation to the alleged contravention of the civil penalty provision of the Code by or on behalf of the Commonwealth.
The compliance period for a Notice will be 28 days beginning on the day after the day that the Notice is issued by the ACCC. The ACCC does have the power to extend the 28 day period or to withdraw a Notice.
Other key changes to the Code
Some of the other key changes which have been proposed in the draft legislation include the following
1. There is a proposed new provision which states that a restraint of trade clause in a franchise agreement has no effect if the franchisee had sought to renew the agreement on substantially the same terms, the franchisee was not in breach of the agreement and had not infringed the intellectual property of the franchisor during the agreement and the agreement is not renewed and either:
- the franchisee claimed compensation because the agreement was not renewed but the compensation was merely nominal and did not genuinely compensate the franchisee
- the agreement did not allow the franchisee to claim compensation if it was not renewed.
2. The proposed new Code also contains a new provision preventing a franchisor from requiring a franchisee to undertake significant capital expenditure during the term of the franchise agreement. However, this excludes:
- expenditure that is disclosed to the franchisee in the disclosure document before entering into or renewing the agreement or extending the term or scope of the agreement
- expenditure incurred by all or a majority of franchisees and approved by a majority of franchisees
- expenditure incurred by the franchisee to comply with legal obligations
- expenditure agreed by the franchisee
- expenditure that the franchisor considers is necessary as a capital investment justified by a statement of the following:
- - the rationale for making the investment
- - the amount of capital expenditure required
- - the anticipated outcomes and benefits
- - the expected risks associated with making the investment.
3. Franchisors will be required to give an information statement to a prospective franchisee as soon as practicable after it becomes apparent to the franchisor that a franchise agreement will be or is likely to be entered into by the prospective franchisee. This does not apply to the renewal of a franchise agreement or the extension of the term of scope of the franchise agreement. The information statement forms new Annexure 2 to the proposed new Code
4. There is a new prohibition on including a clause in a franchise agreement requiring a franchisee to pay the franchisor's costs incurred in relation to settling a dispute. The parties are to pay their own costs of attending mediation.
5. A new provision has been included to the effect that a franchise agreement must not contain a clause that requires a party to the agreement to bring an action or proceeding to a dispute in any other State or Territory other than the State or Territory in which the franchise business is based.
6. Annexure 1 of the Code, which sets out the requirements which are to be met in a disclosure document, has also been modified in certain important respects. Some of these include:
- new clause 7 which requires certain disclosures around master franchises
- new clause 12 dealing with supply of goods or services in relation to online sales
- new clause 18 dealing with arrangements to apply at the end of the franchise agreement.
A disclosure document will also be required to include a table of contents based on the items in Annexure 1 to the Code and list the attachments to the document. Disclosure documents will therefore need to be reviewed and amended to meet the new requirements.
Some welcome changes from a franchisor's perspective are:
- Changes made to franchise documentation to give effect to a franchisee's request, to fill in required particulars, to reflect changes of address or other circumstances, for clarification of a minor nature or to correct errors or references will not trigger the restart of the 14 Day Period Requirements.
- Master franchisors are no longer required to give disclosure documents to a subfranchisee (ie a franchisee of the subfranchisor). However, they will still be required to give the subfranchisor a disclosure document in circumstances where a subfranchisor is proposing to enter into a franchise agreement with the master franchisor, renew a franchise agreement with the master franchisor or extend the term or scope of a franchise agreement with the master franchisor.
- Changes that have been proposed to facilitate the provision of franchise disclosure documentation electronically. The new draft Code contemplates that a person will be taken to have consented to information being given electronically if the person has not advised them in writing otherwise.
Accordingly, the proposed amendments to the Code and the CCA have very serious implications for franchising chains. It is essential to ensure that:
- all new obligations under the revised legislation are fully understood
- systems are reviewed and where required upgraded to ensure all obligations are strictly complied with
- franchise documentation is carefully reviewed and amended to ensure compliance with all new requirements.
If the reforms proceed in their current form, then franchisors will also:
- face the risk of civil penalties or receiving infringement notices for non-compliance with the Code
- need to take extra care when making a variety of decisions relevant to franchisees and prospective franchisees in light of the proposed new statutory obligation to act in good faith
- find it more difficult to enforce restraints of trade and to introduce new requirements involving significant capital expenditure in certain circumstances.
The Franchising Council of Australia has indicated that it is likely to make further submissions regarding the draft legislation and regulations including in relation to the proposed new statutory good faith obligation. We will continue to review and monitor the status of the proposed reforms and will keep you informed of key significant developments.
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.