HWL Ebsworth Lawyers’ Sean O’Donnell, Partner, and Massimo Di Maio, Associate, discuss how the Franchising Code of Conduct requires franchisors to create and maintain a Code-compliant Disclosure Document. Certain obligations are not always complied with to the extent required under the Code, they write.
The Franchising Code of Conduct (Code) requires franchisors to create and maintain a Code-compliant Disclosure Document, which must be in the form and order of Annexure 1 of the Code.
A franchisor must provide a Code compliant Disclosure Document to a prospective franchisee or transferee or to an existing franchisee at least 14 days before granting a new franchise agreement or renewing or extending the term or the scope of an existing Franchise Agreement. Its purpose is to enable a franchisee to make an informed decision and identify any risks before entering into a franchise relationship with the franchisor.
As part of the Code’s requirements, a franchisor must update its Disclosure Document every year within 4 months after the end of its financial year. For example, if a franchisor operates a FY which ended in 30 June 2018, the update must be completed by 31 October 2018. The Code provides for civil penalties of up to 300 penalty units (currently $63,000) for failing to update the Disclosure Document.
Who will benefit from reading the presentation?
The presentation provides a useful checklist for:
2. Legal practitioners who conduct annual Disclosure Documents updates; and
3. Accountants whose clients include franchisors.
Tips and Traps
In addition to the tips and traps discussed in the presentation, experience suggests that the below obligations are not always complied with to the extent required under the Code.
1. Marketing Fund meaningful Information
If a franchisor controls and administers a marketing fund, it must prepare an annual financial statement (AFS) for the marketing for the year ending 30 June 2018 and serve it on its franchisees within 30 days of its preparation. The ACCC has indicated that, in its opinion, simply listing the marketing or cooperative fund’s expenses as broken down by amount and percentage does not constitute “meaningful information” as required under the Code. Based on the ACCC’s public comments, franchisors should include in item 15 as much detailed information from their AFS and prepare as many explanatory notes as is feasible to deal with the:
(a) sources of income received by the Franchisor in relation to the marketing fund (e.g. via franchisee and corporate store contributions and supplier rebates);
(b) nature of marketing or advertising expenses (e.g. social media campaigns, merchandise, radio and television advertisements);
(c) relevant expenditure associated with each marketing or advertising expense, including the percentage spent on production, advertising, administration and other stated expenses; and
(d) geographical area of the expenditure.
Lawyers should remind their franchisor clients to produce this meaningful information so that they can include it in item 15 of the Disclosure Document and accountants should assist their franchisor clients to extract the relevant meaningful information from the AFS.
2. Item 13 – Site or Territory history
The Code requires franchisors to disclose whether a site or territory to be franchised has been subject, in the previous 10 years, to a franchised business operated by a previous franchise granted by the franchisor. If so, the Disclosure Document must include the details of that franchised business including the circumstances in which the previous franchisee ceased to operate. It is critical to remember that the Code requires that this information must be provided with the Disclosure Document but in a separate document.
As a note, this information must be tailored on a case by case basis and must reflect the history of the site or territory for the entire previous 10 years. In order to comply with the Code, this information may be added to the Disclosure Document as a schedule, which can be easily tailored for each grant.
3. Item 18 – End of term arrangements
Item 18 requires franchisors to disclose the arrangements that apply at the end of the Franchise Agreement, which include whether the franchisee will have an option to renew or to extend the term Franchise Agreement. The answers to this item must be tailored on a case by case basis. In particular, items 18.3 to 18.5 include 3 mandatory statements which must be included in the Disclosure Document in size 12 font and bold if the franchisee does not have a renewal option or the option to extend the term of the Franchise Agreement or both.
Similarly to the requirements under item 13, this information must be tailored on a case by case basis and must reflect the circumstances which apply to the individual grant. As an example, if the franchisor is granting a renewal Franchise Agreement, which does not include a further additional term, the mandatory statements in item 1.3 and 18.5 will apply.
4. General tips and Unfair Contract Term (UCT) regime
The annual update is also a good time to ensure that the obligations and payments in the franchise agreement match those summarized in the DD. As an example, where a franchisor introduces additional fees as the system develops, such fees will need to be included in the Disclosure Document and the relevant operative provision should be added to their Franchise Agreement. Likewise, increased operational costs need to be updated annually and provision of wide ranges of costs should be avoided.
As a final note, it is worth mentioning that the UCT regime was extended last year to cover standard form small business contracts entered into, renewed or varied on or after 12 November 2016. Accordingly, UCT regime will apply to those Franchise Agreements which satisfy the applicable thresholds and the operational date. Under this regime a term which is found to be unfair will be void. The test to determine whether a term is unfair is threefold – a term will be unfair if it:
(a) causes significant imbalance between the parties;
(b) is not reasonably necessary to protect a legitimate interest of the party advantaged by the term; and
(c) causes financial or other detriment to a party if it were to be relied on.
As part of the ACCC’s submission to the Senate’s enquiry into the Code, the ACCC has made 10 recommendations, which include making UCTs illegal which, as a direct consequence, will enable the ACCC to seek pecuniary penalties and issue infringement notices for UCT. In light of the ACCC’s recommendations, franchisors should ensure that their Franchise Agreements do not include terms which could be found to fail the unfair test, noting that unfairness is determined by interpretation of the clause in the contract, rather than the conduct of the parties.
This article and the presentation are not meant to be provided as legal or accounting advice.
Sean O’Donnell is one of Australia’s leading franchise and dispute lawyers. He is recognised by his international and local peers as a ‘Thought Leader’ in franchising, an accolade only applying to 4 other lawyers in Australia. He heads up the firms national retail and franchising practice. Sean has 20 years of experience assisting clients involved in the retail and franchise sectors, particularly assisting with strategic change of a network and resolving complex disputes in a broad range of industries. His practice in franchising covers both non contentious advice work to litigated disputes. This unique combination was validated in the publication of Who’s Who Legal 2017 where his clients commended him on his “incredible market understanding”, “commercial and practical advice” and “his superb litigation abilities”. Sean is also listed in Best Lawyers for his franchise expertise. Sean was the President of the NSW/ACT Chapter of the FCA and a director of the FCA National board from 2012 to October 2017. He had a significant role in the drafting and implementation of the new Franchising Code in 2015, including submissions to government about redrafting of the Code. Contact Sean at [email protected]
Massimo Di Maio is an experienced commercial lawyer. His practice is heavily focused on commercial matters relating to franchisors across a wide variety of industry sectors. His experience ranges from advising major Franchisor clients on compliance with the Franchising Code of Conduct and other laws applicable to the Franchising industry, including Unfair Contract Terms, to advising on intellectual property protection, competition issues and commercial leases. His daily transactions include grants, renewals, transfers, surrenders, novations, extensions, variations and terminations of franchise/licence agreements. Massimo’s recent commercial experience includes assisting a client in major private equity acquisition of about 35 franchised businesses, acquisitions of majority shareholding of national franchisors and advising national financial institutions on franchisor accreditation for franchisee finance. Massimo also advises clients on business sales, corporate restructure and franchise dispute matters. Massimo is highly appreciated by his clients for his practical advice, efficiency and general understanding of issues affecting franchisors. Contact Massimo at [email protected]