In a recent case, Ketchell v Master of Education Services Pty Ltd, the New South Wales Court of Appeal has handed down a significant decision that will have far reaching effects on franchisors.
Under clause 11(1) of the Franchise Code of Conduct (Code), a franchisor must receive a written statement signed by the franchisee before entering into a franchise agreement, to the effect that the franchisee had a reasonable opportunity to read and understand the disclosure document and franchisee agreement. The franchisor in this case did not receive this statement.
In a previous case in the Supreme court involving The Cheesecake Shop, which dealt with a similar issue, the court held that failure to obtain the relevant statements required under clause 11(1) of the Code did not render the contracts void for illegality, but left open the position for a franchisee to sue for damages if the franchisee suffered loss as a result of the breach of the code.
The Court of Appeal in Ketchell held that failure to obtain the statement required by clause 11(1) of the Code, renders the franchise agreement void for illegality. This means the franchisor was not able to recover the unpaid royalty and marketing fees. The Court of Appeal specifically overruled the decision in The Cheesecake Shop.
It is clear from this case that a court will not enforce a franchise agreement unless the franchisor has obtained the statements under clause 11 of the Code before entering into the contract.
The court specifically said:
the respondent [franchisor] next submits that the apparent analysis brings down contracts for breach of the Code irrespective of whether the breach is substantial or merely minor, technical or procedural. This is an argument that needs to be taken up with the Parliament. One frequently encounters provisions that relieve against strict compliance…. s51AD & CL 11 of the Code are not qualified in this way. Nor does the Act enable the defaulting franchisor to point to the opportunities available by the franchisee to rely on her own specialist’s advice.
If franchisors do not obtain the statements as required under the Code, or due to some technical problem, do not give a disclosure document to a prospective franchisee within the required timeframe, the franchise agreement will be unenforceable. The franchisor will not be able to recover unpaid royalties. Indeed, there are arguments to suggest that in some circumstances, a franchisor will have to refund any payment received. Clause 11(1)(c) says that a franchisor must not:
receive a non-refundable payment unless the franchisor has received from the franchisee or prospective franchisee a written statement that the franchisee or prospective franchisee has received, read, and had a reasonable opportunity to understand the disclosure document and this code.
There are a number of things we believe franchisors should be doing immediately. First, franchisors need to know if they can enforce their franchise agreements. Therefore, they should do an audit to see if they can prove that they have complied with all requirements of the Code.
Secondly, franchisors may wish to write to the ACCC and to the Minister for Small Business asking for the Code to be changed. The change required is a statement to the effect that non-compliance with the Code does not render a franchise agreement void for illegality, but non-compliance of the Code enables a judge to apply any of the remedies available for a Code breach, including declaring, in appropriate circumstances, that a franchise agreement be rendered void and unenforceable.
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