How to Deal With Underpayments by Franchisees

In Short

• Underpayments can damage your franchise network—monitor payments regularly and review agreements

• Act quickly: communicate clearly, offer support where needed, and follow the dispute resolution process

• Keep your disclosure documents accurate and up to date to avoid confusion and legal risks

Tips for Businesses
Set up strong systems to track payments and schedule regular audits across your franchise network. Address issues early—talk openly with franchisees and offer practical solutions. Make sure your franchise agreement and disclosure documents clearly outline payment obligations to avoid disputes and stay compliant.

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Table of Contents

• Understanding the Legal Framework
• Steps to Address Underpayments
• Other Considerations
• Key Takeaways
• Frequently Asked Questions

As a franchisor, it is crucial to ensure that your franchisees adhere to your franchise system’s financial and operational standards. This adherence will help maintain your brand’s integrity and success while allowing for the growth and expansion of your franchise network. A significant challenge that may arise is managing underpayments by franchisees. This issue can significantly impact a franchisor’s bottom line, potentially leading to larger disputes, damage to the brand, and issues within the network. This article provides a comprehensive guide on handling underpayments by franchisees while protecting a franchised business.

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Understanding the Legal Framework

In Australia, franchising is regulated under the Franchising Code of Conduct. The Code outlines the rights and obligations of both franchisors and franchisees, including disclosure requirements, dispute resolution processes, and party conduct. As a franchisor, it is essential to be familiar with these regulations to ensure compliance and effectively manage any disputes.

To avoid the risk of underpayments, franchisors must be aware of their disclosure obligations. Franchisors must provide a disclosure document to prospective franchisees before entering into a franchise agreement. This document must detail the franchisee’s financial obligations, including:

• ongoing royalties;
• marketing contributions; and 
• other payments. 

By ensuring that their disclosure document is comprehensive and current, franchisors can prevent underpayments from franchisees.

Steps to Address Underpayments

1. Review the Franchise Agreement

The franchise agreement outlines the rights, responsibilities, and obligations of both the franchisor and the franchisee. It typically includes provisions related to royalty payments, marketing fund contributions, and other financial obligations. Additionally, the franchise agreement specifies the steps franchisors must take to correct underpayments, which may include charging interest on overdue amounts or issuing a breach notice to franchisees who consistently underpay. 

Regularly reviewing your franchise agreement ensures that it accurately reflects the current terms and conditions of the franchise relationship. Any discrepancies or ambiguities in the agreement should be addressed promptly to prevent misunderstandings regarding payment obligations.

2. Implement Robust Financial Monitoring

Establishing a robust system for financial monitoring is crucial for franchisors to effectively manage their franchisees’ financial obligations. This may involve implementing accounting software or systems that track franchisee payments automatically.

Regularly monitoring financial transactions allows franchisors to identify discrepancies, such as missed royalty payments or underreported sales figures, which may indicate potential underpayments. Additionally, periodic audits can further assure financial compliance across your network while helping identify irregularities.

3. Conduct Regular Audits

Regular audits also help franchisors verify the accuracy and completeness of franchisee financial records. It also allows franchisors to assess the franchise network holistically and more accurately. 

Audits should be conducted in accordance with established procedures and cover various aspects of financial compliance across the network. By reviewing financial documents and conducting on-site inspections where necessary, franchisors can assess franchisee compliance with the terms of the franchise agreement and identify any instances of underpayment or financial mismanagement. It can also allow the franchisor to provide or tailor any training for franchisees and better assess the support they should be providing their network. 

4. Communicate Clearly and Promptly

Clear and prompt communication is essential when addressing underpayments by franchisees.

If a franchisee fails to make a payment (or underpays), franchisors should communicate with the franchisee in a transparent and supportive manner. Providing detailed information about the discrepancy, such as specific payment amounts the franchisor believes are due and relevant transaction records, helps facilitate productive discussions and enables franchisees to understand the issue more clearly. In some circumstances, franchisees may not even know they are underpaid.

Open communication fosters trust and cooperation between franchisors and franchisees, laying the groundwork for resolving underpayment issues quickly and amicably. Additionally, it enables both parties to rectify the situation before it snowballs into a more significant problem. 

5. Offer a Payment Plan

In cases where franchisees are unable to meet their financial obligations due to genuine difficulties, franchisors should consider offering a payment plan to assist with repayment.

A payment plan allows franchisees to spread the repayment of outstanding amounts over a defined period, making it more manageable for them to address the shortfall while continuing their operations. By showing flexibility and understanding, franchisors can effectively support franchisees during challenging times. This approach can preserve the long-term viability of the franchise relationship and demonstrate to the franchise network that there is authentic support from the franchisor.

6. Utilise Dispute Resolution Mechanisms

The Franchising Code of Conduct requires that all franchise agreements incorporate a dispute resolution mechanism to facilitate the resolution of any disputes between franchisors and franchisees. If direct negotiations do not resolve an underpayment issue, franchisors and franchisees can use mediation to seek a mutually acceptable solution. 

Mediation involves the appointment of an independent mediator who facilitates discussions between the parties and helps them reach a voluntary agreement. By employing dispute resolution mechanisms, franchisors and franchisees can avoid costly and time-consuming litigation, resolving underpayment issues efficiently and collaboratively.

Other Considerations

As previously mentioned, the Franchising Code imposes a general obligation on both franchisors and franchisees to act in good faith in their dealings, including underpayments. This means parties must behave honestly, fairly, and cooperatively, without any ulterior motives. Failure to act in good faith can result in penalties and damage the franchisor’s reputation.

Franchisees also have protections under the Australian Consumer Law (ACL), which prohibits misleading or deceptive conduct. If a franchisee claims they were misled about the financial obligations of the franchise, they may have grounds for a complaint under the ACL. This again highlights the importance of franchisors providing comprehensive and accurate disclosure documents. 

Key Takeaways

Understanding and adhering to the Franchising Code is essential for effectively managing underpayments by franchisees. By complying with their obligations, maintaining accurate records, and engaging in good faith negotiations, franchisors can address underpayment issues efficiently and uphold the integrity of their franchise system. 

If you need help dealing with franchisee underpayments, our experienced franchise lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page. 

Frequently Asked Questions

What is an underpayment by a franchisee?
An underpayment occurs when a franchisee fails to pay the full amount owed under the franchise agreement, such as royalties, marketing contributions, or other required fees.

Why is it important for franchisors to address underpayments promptly?
Underpayments can impact the franchisor’s revenue, lead to disputes, damage the brand’s reputation, and affect the overall health of the franchise network.