The New Franchising Code: A new era for franchising
The Australian Government has now released the new Franchising Code of Conduct (New Code) which is set to take effect from 1 January 2015.
The New Code has a number of important changes and it is important for franchisors to have a good understanding of their obligations under the New Code. Franchisors also need to be aware that non-compliance with a number of obligations will now attract new civil penalties of up to $51,000, and can also attract an infringement notice from the Australian Competition and Consumer Commission of $8,500 (for companies).
The New Code differs in some respects from the exposure draft released earlier this year in April. In this update, we will examine some of the key differences from the April exposure draft and focus on the following:
- transitional arrangements;
- the statutory obligation to act in good faith;
- civil penalties and infringement notices; and
- other key aspects of the New Code.
The New Code has in place certain transitional arrangements including the following:
- There is a "grace period" before existing disclosure documents are required to be updated in accordance with the New Code, until 31 October 2015 (rather than being required to update at the commencement of the New Code on 1 January 2015). Further, the New Code allows a franchisor to use and rely on an existing disclosure document, being one within the meaning of the 1998 Code, until 1 November 2015. Where a franchisor creates a disclosure document on or after 1 January 2015, it is also required to update that disclosure document within four months of the end of the financial year.
The Explanatory Statement to the New Code contains the following examples to illustrate how this "grace period" operates:
Example 1: A franchisor, Gitani Skip Bins, operates on a 1 July – 30 June financial year. Gitani Skip Bins must update its existing disclosure document to comply with the New Code by 31 October 2015.
Example 2: A subfranchisor, Cameron Trivia Quizzes, operates on the same 1 October to 30 September financial year as its master franchisor, an American company. In accordance with the New Code, Cameron Trivia Quizzes must update its disclosure document to comply with the New Code by 31 October 2015. Cameron Trivia Quizzes would be required to next update its disclosure document by 31 January 2017.
A franchisor whose financial year means it does not have to update its disclosure document for more than 12 months after 31 October 2015 should bear in mind though its statutory good faith obligations, the requirements in the New Code to provide "materially relevant facts" within certain timeframes and its obligations under the Australian Consumer Law (particularly its obligation not to engage in misleading or deceptive conduct).
- The New Code prohibits certain provisions in franchise agreements (for example, general releases of the franchisor from liability towards the franchise, provisions requiring proceedings to be brought outside the jurisdiction in which the franchised business is based and also restraint of trade clauses in certain circumstances) which are entered into on or after 1 January 2015. The validity of these clauses in franchise agreements entered into before 1 January 2015 would also be affected if the relevant franchise agreement is extended, varied or transferred on or after 1 January 2015.
- The statutory good faith obligation will apply to conduct engaged in on or after 1 January 2015.
Good Faith Obligation
The New Code contains a statutory obligation to act in good faith, and the drafting of this obligation differs in several respects from the April exposure draft. The obligation, which applies to both franchisors and franchisees, has been framed as an obligation to act in good faith "within the meaning of the unwritten law from time to time." In determining whether this obligation has been contravened, a Court may have regard to:
- whether the franchisor (or franchisee) acted honestly and not arbitrarily; and
- whether the franchisor (or franchisee) co-operated 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 New 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; and
- the New Code.
However, the obligation is expressed not to prevent a person from acting in his, her or its legitimate commercial interests. Further, if a franchise agreement does not give a franchisee an option to renew the franchise agreement or allow a franchisee to extend the agreement this does not mean the franchisor has not acted in good faith in negotiating or giving effect to the agreement.
The good faith obligation should be considered in relation to 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;
- the negotiation of terms of a franchise agreement and dealings with prospective franchisees;
- renewal or extension 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; and
- disputes with franchisees or proposed franchisees.
The Explanatory Statement to the New Code indicates that the obligation to act in good faith is not intended as a panacea for all potential misconduct in the franchising relationship. Franchisors will also need to remain conscious of other provisions contained in the Competition and Consumer Act 2010 (Cth), particularly the prohibitions in relation to unconscionable conduct and misleading or deceptive conduct.
New Civil Penalties and Infringement Notices
The New Code contains a number of "civil penalty provisions". Breach of these obligations in the New Code can attract a civil penalty of up to $51,000 per breach. Further, the ACCC will also have the power to issue an infringement notice of $8,500 (for companies) where the ACCC has reasonable grounds to believe a breach of a civil penalty provision has occurred.
A franchisor faces a civil penalty or an infringement notice if it does not give a franchisee:
- a copy of the New Code;
- a disclosure document as updated as required by the New Code; and
- 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; or
- pays a non-refundable deposit in relation to the proposed franchise agreement,
(14 Day Requirements).
Other civil penalty provisions include the obligations to:
- act in good faith;
- create a disclosure document that complies with the requirements of the New Code (subject to the "grace period" for existing disclosure documents);
- update the disclosure document within 4 months after the end of the each financial year (subject to the transitional arrangements described above);
- give franchisees a copy of a lease or agreement to 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 within 30 days of the statement being prepared;
- 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;
- give a franchisee a disclosure document requested by the franchisee in writing within the required timeframe (which will generally be 14 days);
- where updated financial documents come into existence after an up-to-date disclosure document is given to a franchisee or prospective franchisee but before the franchise agreement is entered into, provide updated financial documents to the franchisee as soon as reasonably practicable but in any event before the franchise agreement is signed;
- make disclosure of "materially relevant facts" as required by the New Code within a reasonable time of being aware of the relevant matter (but not more than 14 days after becoming aware), such as (for example) where there are changes of control of a franchisor, changes of intellectual property material to the franchise system, certain judgments, orders or undertakings are made against a franchisor or a franchisor becomes an externally-administered body corporate;
- 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) and that the franchisee may request a disclosure document in writing (unless the franchisor does not intend to renew the agreement);
- give notices required by the New Code where terminating for breach or in accordance with a franchise agreement without the franchise's consent;
- not engage in conduct with the intention of influencing a former franchisee to make a request that their details not be disclosed to a prospective franchisee;
- not engage in conduct that would restrict or impair the freedom of franchisees or prospective franchisees to associate with other franchisees or form an association; and
- attend a mediation provided for pursuant to the Code.
Other Key Aspects
Some of the other key aspects of the New Code include the following:
- A restraint of trade clause in a franchise agreement entered on or after 1 January 2015 (or in a document incorporated into the franchise agreement) will have no effect if:
- the franchisee gives written notice to the franchisor seeking to renew the agreement on substantially the same terms as those contained in the franchisor's current franchise agreement that apply to other franchisees or would apply to a prospective franchisee – not necessarily the agreement the franchisee is on at the time their agreement ends; and
- the franchisee was not in breach of the franchise agreement or any related agreement;
- the franchisee has not infringed the intellectual property of, or any confidentiality agreement with, the franchisor during the agreement the franchisor;
- the franchise 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; or
- the agreement did not allow the franchisee to claim compensation if it was not renewed.
- Franchisors are prevented 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;
- if expenditure is to be incurred by all or a majority of franchisees, expenditure approved by a majority of those franchisees;
- expenditure incurred by the franchisee to comply with legislative obligations;
- expenditure agreed by the franchisee; and
- expenditure that the franchisor considers is necessary as a capital investment in the franchised business justified by a written statement given to each affected franchisee of the following:
- the rationale for making the investment;
- the amount of capital expenditure required;
- the anticipated outcomes and benefits; and
- the expected risks associated with making the investment.
- Franchisors will be required to give an information statement to a prospective franchisee as soon as practicable after the prospective franchisee formally applies or expresses an interest in acquiring a franchised business. 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 Annexure 2 to the New Code.
- It is prohibited to include 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 but are equally liable for the costs of mediation unless they agree otherwise.
- 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 (or country) other than the State or Territory in which the franchise business is based.
- The timing requirements in relation to consents to transfers of a franchise agreement have changed – consent will now be deemed to be provided if the franchisor does not advise the person seeking consent that consent is not given within 42 days of the later of the date the request for consent is made and, if further information is requested regarding the transfer, the date the last of the information requested is provided. Consent can also be revoked (but not unreasonably).
- 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 item 7 which requires certain disclosures around master franchises.
- new item 12 dealing with supply of goods or services in relation to online sales.
- new item 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.
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.
We recommend that:
- franchisors review their franchise agreements so that they are ready to comply from 1 January 2015;
- franchisors either review their disclosure documents now or take advantage of the "grace period" if they have an existing disclosure document;
- systems are reviewed and, where required, upgraded to ensure all obligations in the New Code are strictly complied with. Franchisors will need to take particular care to ensure certain New Code requirements are met (eg 14 Day Requirements) or face risk of civil penalties or receiving infringement notices for non-compliance;
- franchisors also 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 such as negotiations, unilateral variations, renewals and terminations;
- franchisors review their insurance cover for civil penalties and infringement notices.
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.