As a franchisor, you need to ensure that your business is up to date with consumer trends. However, you also need to avoid overburdening your franchisees with expensive refurbishments. If you decide that a major renovation is necessary, you must have a legal basis for enforcing the change. This article outlines the key legal issues you should consider before you require franchisees to undertake refurbishments.

Understand the Franchising Code of Conduct

You must remain aware of any proposed changes to the Franchising Code of Conduct (the Code). This document is a mandatory set of regulations that governs your relationship with franchisees. 

Currently, the Code mandates that you cannot require the franchisee to spend “significant capital expenditure”. However, there are some exceptions, including where the spending:

  • is disclosed before the signing of the franchise agreement in your disclosure document
  • has been approved by all or a majority of franchisees;
  • is required to comply with legislation; or
  • is considered necessary and you have justified the expense in a written statement. 

However, you should regularly update your knowledge of the Code in case there have been any changes that could affect when a franchisor can require significant expenditure. It could also influence the way that you assess franchisee expenditure in end of term arrangements. Failing to comply with the Code could incur substantial financial and reputational damage to your business.

Will the Refurbishment Require “Significant Capital Expenditure”?

The Code does not expressly define what ‘“significant capital expenditure” is. However, conventional understanding is that this kind of expenditure requirement does not relate to the ordinary operations of the business. This means that the Code does not prevent you from requiring franchisees to incur general expenses associated with a franchised business, such as:

  • payroll;
  • rent; and
  • stock purchases. 

In contrast, you would consider spending on substantial equipment replacements or renovations to the fit out of the premises to be exceptional expenses because they require a “significant capital investment”.

For example, you may change your brand colour scheme or logo which would require refurbishment to update signage and the store fit out. This is likely to require substantial investment by the franchisee and will therefore be “significant capital expenditure”. However, minor upgrades or maintenance may not meet this threshold.

If you want to require your franchisees to undertake any major upgrade or modification to their premises, you must ensure that the requirement fits into one of the exceptions under the Code.

Have You Disclosed the Expenditure to Franchisees?

You may require franchisees to undertake “significant capital expenditure” where you disclosed the expenditure to the franchisee in the disclosure document. This is a legal document outlining all the information a franchisee needs to know before entering into or renewing their franchise agreement, including what expenditure you require them to undertake.

You can generally require franchisees to undertake the refurbishment if your disclosure document clearly outlines the:

  • requirement; and
  • estimated cost.

However, you may not mandate significant expenditure if the final cost to franchisees exceeds the estimated cost you provided in the disclosure document.

Has the Franchise Approved the Expenditure?

You can only mandate “significant capital expenditure” where a majority of franchisees have approved the requirements 

This can occur after asking your franchisees to vote on whether the whole system should proceed with a proposed refurbishment or refreshment. However, this exception is only applicable where a majority of franchisees will incur the expense,

For example, if the requirement only affects franchisees who have operated their franchise for five or more years, and only 20% of franchisees fall into that category, you cannot rely on a vote cast by all franchisees in the system to justify the expense.

Is the Required Refurbishment Legally Required? 

Depending on your industry, there may be occasions where a capital expenditure requirement is necessary to comply with updates to the law.

For example, a franchise system involving food processing may have new regulatory requirements relating to the: 

  • environment where food processing must occur; or
  • type of equipment that you must use to carry out that processing.

If the law changes, you should help communicate the effect of any new obligations to your franchisees. Depending on the amount of expenditure required, you should also set out any directions or proposed implementation to comply with the changes.

Is the Required Refurbishment a Necessary Capital Investment?

Finally, you can impose capital expenditure requirements if you consider it to be a necessary investment in the franchised business. In this situation, you must justify your reasoning in a written statement given to each affected franchisee.

This written statement should include the:

  • reasons for requiring the investment with consideration to the cost and timing of the expenditure;
  • amount of expenditure needed as part of the refurbishment or upgrade;
  • expected benefits of the investment, supported by market research; and
  • risks associated with making this investment. 

You may also need to consider any “significant capital expenditure” requirements imposed upon franchisees by attributing compensation or value to that expenditure when the franchisee exits the franchise. 

Key Takeaways

You must ensure that you have a legal basis to enforce spending before requiring that franchisees undertake substantial refurbishments or other significant capital expenditure. This will be permitted where:

  • you have disclosed the estimated cost of your proposed renovations in the disclosure document before, the franchisee signs up or renews your agreement;
  • the requirements approved by a majority of franchisees who will incur expenditure due to the changes;
  • the refurbishments are required to comply with any changes to legislation; or
  • you consider the refurbishments to be necessary and have justified your reasoning in a written statement to each affected franchisee.

If you are looking for advice on whether you can require franchisees to undertake refurbishments, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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