The release of the report resulting from the Parliamentary Inquiry into the Operation and Effectiveness of the Franchising Code of Conduct (the Code) is the next shake-up to the franchising sector.

The report recommends several changes to the Code that will have wide-reaching implications for both franchisors and franchisees. For franchisors, the report signals more stringent disclosure requirements and significantly higher penalties for infringement of the Code.

In contrast, for franchisees, the report indicates a move towards working with other franchisees to negotiate with franchisors and protections concerning significant capital expenditure.

This article provides a summary of the report’s key issues, including:

  • why the issues are of concern;
  • how existing law is likely to change as a result of the report; and
  • what franchisors and franchisees can do in the wake of the report.

Disclosure of the Likely Financial Performance of a Franchise

Current Legal Requirement

At present, franchisors are not required to provide any:

  • historical financial information relating to the franchise a prospective franchisee is proposing to acquire; and
  • projection or estimation of earnings.

The Current Problem

Franchisors are not always transparent about the likely financial performance of the franchise that prospective franchisees are looking to purchase. They also may not provide meaningful financial information to help a franchisee assess how their franchise may perform.

As a result, this can make estimating the return on their investment very difficult for prospective franchisees and can result in franchisees feeling misled if the franchise does not perform as well as hoped. For franchisors, this can breed tension and turn franchisees into brand detractors.

Regulatory Change Recommended by the Report

The report recommends that prospective franchisees must receive:

  • business activity statements for the last two years;
  • a profit and loss statement;
  • balance sheets (statement of financial position); and
  • an assessment of labour costs.

If the franchise is a new site, the franchisor must provide the prospective franchisee the business activity statements, profit and loss statements and balance sheets of a comparable franchise.

Franchisors should consider what historical financial information they currently offer to prospective franchisees.

Prospective franchisees may wish to request this information in the process of buying a franchise, noting they may be legally entitled to receive this information in a timely manner.

The Need for a Public Register of Franchise Documents

Current Legal Requirement

Presently, franchisors must:

  • provide their franchise agreement and disclosure documents to prospective franchisees at least 14 days before signing; and
  • update their disclosure document each year unless certain exceptions apply.

Furthermore, franchisors do not need to make their documents public.

The Current Problem

The report identified that a lack of public disclosure means that it is challenging for the Australian Competition and Consumer Commission (ACCC) to ensure franchisors are meeting disclosure requirements under the Code. As a result, prospective franchisees may be receiving inadequate disclosure before entering into a franchise agreement.

The report also noted that the lack of a requirement for public disclosure might be a factor in some franchisors failing to regularly update their disclosure document.

Regulatory Change Recommended by the Report

Although it recognised the potential benefits of a public register of franchise systems, the report did not make it an outright recommendation.

Instead, the report recommends the establishment of the franchising taskforce, a body that will further consider some of the issues identified in the report. The franchising taskforce will investigate options for a public franchise register with franchisors providing updated documents annually.

Franchisors should ensure they are compliant with the disclosure document updating requirements of the Code, in preparation for the possibility of a public register.

Franchisees Engaging in Collective Action

Current Legal Requirement

At present, the Code does not reference or facilitate any form of collective bargaining. Instead, the Code governs individual franchise agreements between a franchisor and franchisee.

The Current Problem

Often, franchisees lack bargaining power in negotiations with their franchisor. In part, this is due to the notable difference in resources between franchisors and franchisees, with franchisees unable to engage in lengthy negotiations.

Further, the report notes that franchisors have an uninhibited ability to force system-wide changes even where a majority of franchisees oppose it.

Regulatory Change Recommended by the Report

The report recommends that it be lawful for all franchisees to collectively bargain with their franchisor, regardless of their size or other characteristics.

Some franchisors facilitate a form of collective bargaining within their franchise systems, where a group of representative franchisees must approve system changes.

Franchisors should consider embracing this model and working out now how best collective action could be utilised in their systems. Franchisees may wish to inquire with their franchisor about the possibility of establishing a franchisee committee for this purpose.

Disclosure of Rebates and Supply Chain Requirements

Current Legal Requirement

At present, franchisors must:

  • firstly, disclose the names of all suppliers from whom rebates are received (but not the amounts);
  • secondly, indicate whether they will share rebates with franchisees; and
  • finally, disclose whether franchisees must acquire goods or services from a specific source.

The Current Problem

The report notes that franchisees often appear to be required to purchase stock or equipment from suppliers that are far more expensive than others in the market, with the franchisor receiving an undisclosed amount back as a rebate.

Regulatory Change Recommended by the Report

The report recommends mandatory disclosure by franchisors in percentage terms of all:

  • supplier rebates;
  • commissions; and
  • other payments concerning the supply of goods or services to franchisees.

It also recommends that franchisors be required to disclose, for the prior two years:

  • any instance where the maximum resale price of an item has been below the cost price; and
  • the margin between the purchase price and the maximum price or recommended resale price of the top five goods or services sold.

Franchisors should begin calculating and tracking this data and consider reviewing any practices where franchisees’ acquisition cost of goods is higher than maximum resale prices, noting that these costs will likely have to be clearly disclosing this in the future.

Franchisees may wish to refer to the report recommendation to request disclosure of rebate amounts on a percentage basis.

Dispute Resolution Under the Franchising Code

Current Legal Requirement

Currently, the Code provides for a dispute resolution scheme which amounts to a mandatory mediation procedure administered by the dispute resolution adviser appointed under the Code.

The Current Problem

While mediation provides parties with a forum to air their grievances, the effectiveness of the process is heavily dependant on the willingness of both parties to engage with the mediation process and try to achieve an outcome. Ultimately, many franchisees have complained that the scheme does not produce adequate results.

Further, unless all parties agree, mediation is only between the franchisor and one franchisee, irrespective of there being a common issue faced by several franchisees.

Regulatory Change Recommended by the Report

Firstly, the report recommends that the recommendation concerning collective action should apply to the dispute resolution processes mandated by the Code, to allow for the resolution of disputes affecting several franchisees.

Further to this is the recommendation that the Code is expanded to include binding arbitration with the capacity to award:

  • remedies;
  • compensation;
  • interest; and
  • costs.

Binding arbitration is a dispute resolution process typically used to achieve the determination of a dispute without the need for court proceedings.

Franchisors should focus on strengthening their internal dispute resolution mechanisms built into their systems to avoid unnecessarily escalating the issue or complaint.

Franchisors should also consider where it may be appropriate to tackle an issue or dispute collectively where the same impacts several franchisees.

The Impact of the ‘Unfair Contract Laws’ on Franchise Agreements

Current Legal Requirement

The unfair contract laws were introduced into the Australian Consumer Law (ACL) to allow a court to strike out unfair terms from standard form contracts with small businesses.

At present, the courts have not thoroughly tested the application of these laws to franchise agreements.

The Current Problem

The report notes that these laws have the potential to provide additional protections for franchisees by prohibiting unfair terms in franchise agreements.

This said, the introduction of these laws has had little impact on the franchising sector to date.

Regulatory Change Recommended by the Report

The report states that it is ‘unacceptable that franchisors can retain unfair contract terms’ such as unilateral changes to the business model or setting menu prices below cost. Further, the report recommends that the franchising taskforce examine the appropriateness of:

  • making unfair contract terms in franchise agreements illegal; and
  • establishing penalties.

In addition to the above, the report recommends that variations of a franchise agreement are only made with the approval of the majority of franchisees within the franchise system.  

Franchisors should review their standard franchise agreement in light of unfair contract laws. Additionally, franchisors should review how they currently make system changes, and whether they have the approval of a majority of franchisees.

On the other hand, franchisees should request a consultation about system changes before implementation.

Termination Rights for Franchisees

Current Legal Requirement

Currently, the Code provides for termination:

  • by the exercise of cooling-off rights (by the franchisee);
  • following an unremedied breach (by the franchisor); and
  • in ‘special circumstances’, immediate termination (by the franchisor).

The Current Problem

The report considered:

  • firstly, whether the current status quo of termination rights adequately protect franchisees’ interests; and
  • secondly, whether franchisees should have an express right of termination in any circumstance, such as in the event of franchisor breach or default.

Submissions made to the Inquiry highlight that franchisees can be, in effect, left without a remedy where their franchisor undergoes a significant change, such as the franchisor going into administration.

Regulatory Change Recommended by the Report

Firstly, the report recommends that the same right of termination for ‘special circumstances’ currently afforded to franchisors also be given to franchisees.

Further, the report has suggested that the Code also incorporate exit and termination rights for franchisees when:

  • the franchisee faces ‘hardship’, which would include a ‘cap’ on damages the franchisor could claim against the franchisee;
  • there has been exploitation by the franchisor; or
  • business failure occurs, with both parties agreeing to terminate.

Irrespective of whether these recommendations become law, franchisors may wish to consider whether there may be some use in providing an express right of termination to franchisees, subject to certain conditions.

If adopted, these changes will potentially result in franchisors having the responsibility of reacquiring sites and assuming leases in certain circumstances.

Compensation for ‘Significant Capital Expenditure’ Undertaken by Franchisees

Current Legal Requirement

Currently, the Code prohibits franchisors from requiring a franchisee to undertake significant capital expenditure except for certain circumstances, including where the:

  • requirement has been disclosed to the franchisee in the disclosure document;  
  • all or a majority of franchisees have approved expenditure; or
  • franchisor considers it necessary as capital investment in the franchised business.

The Current Problem

The Inquiry found that, despite the existing Code requirements, many franchisees were:

  • required to undertake significant capital expenditure; and
  • often unable to obtain any return on investment because the expense was not considered in any valuation of the business before a transfer or expiry.

Regulatory Change Recommended by the Report

On this issue, the report recommends that there be appropriate constraints on the ability of franchisors to impose capital expenditure requirements on franchisees to ensure that franchisees:

  • can make a return on investment within the remaining franchise agreement; or
  • only have to pay for a pro-rata portion of the capital expenditure to allow for such a return; or
  • are paid compensation by the franchisor if the franchisor subsequently terminates the franchise agreement (after requiring significant capital expenditure).

In light of this recommendation, franchisors should review their practices with regards to requiring significant capital expenditure to assess whether their current practices are likely to comply with these recommendations.

Franchisees should query their franchisor as to the terms of any significant capital expenditure requirements, including whether the value of such expenditure will be considered in any valuation of the franchise business.

The Effectiveness of Penalties Under the Code as a Deterrent

Current Legal Requirement

At present, a breach of the Franchising Code can attract the imposition of a civil penalty of up to $63,000.

Suspected breaches can also see the ACCC issue infringement notices, resulting in the infringing party paying a fine.

The Current Problem

In their submission to the Inquiry, the ACCC stated that the current penalties available for breaches of the Code:

  • are  ‘manifestly inadequate’; and
  • subsequently, fail to provide any meaningful deterrent to large franchisors.

Regulatory Change Recommended by the Report

The report recommends that:

  • civil monetary penalties and infringement notices be made available for all breaches of the Code; and
  • that the value of those penalties available for such offences be significantly increased to ensure that sanctions are a meaningful deterrent.

It also recommends that the franchising taskforce examine an amendment to the ACL concerning unfair contract laws.

Franchisors should ensure their strict compliance with the Code. Doing so will mean they are not left open to penalties for infringement notices, with the value of such penalties likely to rise following the report’s recommendation.

Key Takeaways

The Parliamentary Inquiry report provided over 70 recommendations for changes to the franchising sector. Some of the key issues covered in the report include:

  1. disclosure of the likely financial performance of a franchise;
  2. the need for a public register of franchise documents;
  3. the need for franchisees to engage in collective action;
  4. disclosure of rebates and supply chain requirements;
  5. the effectiveness of dispute resolution;
  6. the impact of ‘unfair contract laws’;
  7. termination rights for franchisees;
  8. compensation for significant capital expenditure; and
  9. the effectiveness of penalties under the Code.

An experienced franchise lawyer can:

  • review your documents to ensure that you are complying with the Code; and
  • additionally, provide advice about how to best prepare your franchise business for the changes the report may bring.

If you have any questions about the report, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

Jonathan Muncey
If you would like further information on any of the topics mentioned in this article, please get in touch using the form on this page.
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