Are the days when you had no bargaining power with the franchisor a thing of the past?
The Australian Government has long recognised the importance of the franchise industry to the small business community in Australia. To further promote growth in the franchise sector, reduce red tape, and encourage best practice principles, a new Franchising Code of Conduct (Code) came into effect on 1 January 2015.
Additionally, the new Unfair Contract Terms regime (UCT regime) under the Australian Consumer Law (ACL) came into effect on 12 November 2016. Under the UCT regime, the bargaining power between you and the franchisor has been equalised.
When buying a franchise, it would be wise for you to understand your rights so that you can make an informed decision before signing the franchise agreement.
How does the code help you?
The Code provides that a franchising agreement cannot be entered into unless the franchisor provides a potential franchisee with:
- A short information statement highlighting the risks and rewards of franchising;
- A copy of the Code;
- A copy of the disclosure document; and
- A copy of the franchise agreement.
These must be provided at least 14 days prior to entering into the franchise agreement.
If you intend to lease premises through the franchisor, the franchisor is also required to provide you with a copy of any lease, sub-lease or licence and details of any lease incentives or financial benefit that the franchisor is entitled to receive from the landlord.
How do these documents help you?
These 14 days are crucial for you to conduct your legal due diligence and the franchisor cannot rush you into entering into a franchise agreement. As soon as you get the documents, you should carefully read them, as they contain valuable information that you wouldn't otherwise know. This will help you to decide whether to take up the franchise or not.
Amongst other things, the disclosure document sets out whether there is any ongoing legal proceeding against the franchisor, whether the franchisor has gone bankrupt before, the expected set up and operational costs of the business, the number of franchisees and their contact details, the number of franchise businesses that have been terminated or discontinued either by the franchisor or franchisee(s), and the financial reports of the franchisor.
All this information can assist you in making a decision on whether the franchise business is a viable one, and if you might potentially encounter problems with the franchisor in the future. You may even contact other franchisees to get a sense of the franchise and whether they have any disputes with the franchisor.
At the same time, it is highly recommended for you to seek appropriate independent legal and financial advice.
Can I terminate the agreement?
If you do not wish to buy the franchise after conducting due diligence, the Code gives you a cooling off right where you are able to terminate either an agreement to enter into a franchise agreement, or the franchise agreement if it has already been entered into, within seven days of entering into such agreement or making any payment under the agreement (whichever is earlier). This cooling off period only applies to a new agreement, and does not apply to a transfer, renewal or extension of an existing franchise agreement.
If you decide to terminate the agreement during the cooling off period, any payments that you have made to the franchisor under the agreement (minus franchisor's reasonable expenses) would need to be returned to you within 14 days.
What other protections do I have under the Code?
In addition to the above, the Code also provides you with the following general protections:
- Obligation to act in good faith: both parties to a franchise agreement have to act in good faith in respect of all matters relating to the Code and franchise agreement;
- Transfer: should you wish to sell the franchise business in the future, you may need to obtain consent from the franchisor for the transfer of the franchise agreement. However, under the Code, such consent cannot be unreasonably withheld by the franchisor;
- Termination: the franchisor must give you notice in the event of an alleged breach, except in certain special circumstances (e.g. if you acted fraudulently or become bankrupt), where the franchisor may be able to terminate the agreement with immediate effect; and
- Dispute resolution: the Code provides a dispute resolution procedure through mediation.
The UCT regime
The Code is franchisee friendly and with the new UCT regime you might be getting additional protection, as the UCT regime has been extended to protect small businesses.
How does the UCT regime help you?
From 12 November 2016, the ACL has been extended to protect small businesses from unfair terms in a standard form contract. It is important for you to understand how the UCT regime applies and your rights under the UCT regime as many franchise agreements would be caught.
How does the UCT regime apply?
The UCT regime will apply to franchise agreements entered into or renewed on or after 12 November 2016, if the franchise agreement:
- Is a standard form contract;
- Is a small business contract; and
- Includes a term in the franchise agreement which is unfair.
What is a standard form contract?
A standard form contract is typically one where the party who did not prepare the agreement (franchisee/you) is unable to genuinely negotiate the terms of the contract with the other party (franchisor) and has to enter the agreement on a 'take it or leave it' basis.
Some might argue that the parties usually do negotiate the terms of the agreement during the pre-contractual phase. However in practice, a franchisor would generally have a standard form franchise agreement that it offers to all of its franchisees and would not negotiate the terms with each of its franchisees beyond some of the basic terms like fees and territory.
What is a small business contract?
A franchise agreement will be a 'small business contract' if:
- At the time of entering into the contract, either you or the franchisor has less than 20 employees; and
- The amount payable (called the upfront price in the UCT regime) is less than $300,000 (or $1,000,000 if the contract is longer than 12 months).
Very often, franchisees have less than 20 employees at the time of entering into a franchise agreement and most franchise agreements are signed for a term of five or ten years with an amount payable of less than $1,000,000. As such, with no genuine opportunity to negotiate the terms of the franchise agreement, many franchise agreements would fall under the UCT regime.
What does unfair mean?
A term in your franchise agreement will be unfair if it:
- Causes a significant imbalance in the parties' rights and obligations;
- Is not reasonably necessary to protect the franchisor's legitimate interests; and
- Will cause detriment to you (whether financial or otherwise) if relied on.
What clauses should I look out for?
Over the past 12 months (ending 11 November 2016), the Australian Competition and Consumer Commission (ACCC) who is the enforcer of the UCT regime, has worked with businesses in the franchising industry to identify the common terms that are likely to be considered unfair.
The ACCC found that potential unfair terms in a franchise agreement include:
- Operations manuals: a franchise agreement usually gives franchisors unilateral right to vary operations manuals without consulting with the franchisees. In practice, although operations manuals are separate to the franchise agreement, they often set out franchisees' obligations and the franchise agreement usually provides that non-compliance with the operations manual will result in a breach under the terms of the franchise agreement, which gives the franchisor the right to terminate the agreement. The ACCC considers that a franchisor having such broad and unrestrained power to unilaterally amend operations manuals would most likely be considered to be unfair;
- Liquidated damages: a fixed sum payment of liquidated damages to the franchisor in the event of a breach by the franchisee, for example a penalty of $1,000 for failure to attend a training session, appears to simply penalise a franchisee and may be deemed unfair;
- Restraint of trade: terms that contain unreasonable cascading values for the restraint period and restraint area may raise some concerns; and
- Termination: terms that grant the franchisor an unreasonable power to terminate a franchise agreement are likely to be found to be unfair. For example, the ACCC considers a termination clause would most likely be unfair if a franchisor could terminate a franchise agreement without considering the seriousness of the breaches or whether the franchisee has tried to remedy the breach.
What can I do if I think that a term is unfair?
- Before you sign the franchise agreement: you can ask the franchisor to remove or amend the term so it is no longer unfair.
- After you have signed the franchise agreement: if a dispute arises, a court or tribunal may determine whether a term of a contract is unfair.
In both instances, you should obtain advice from a lawyer.
What happens if a term is declared unfair?
If a court makes a declaration that the term is unfair, the unfair term will be deemed void which means that the unfair term does not bind the parties and will be unenforceable. The rest of the franchise agreement would however continue to bind the parties if it is capable of operating without that unfair term.
As this UCT regime is still in its infancy, it is yet to be seen how effective this regime will be in benefiting franchisees. In the meantime, we recommend that you seek legal advice from lawyers with experience in franchising law with the review and negotiation of your franchise agreement.
Madgwicks' Franchising Team has experience across a variety of franchise industries representing both franchisors and franchisees.
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. Madgwicks is a member of Meritas, one of the world's largest law firm alliances.