Time to update — the changes to the Franchising Code of Conduct

Under the new changes to the Franchising Code of Conduct, franchisees will be entitled to more information about the risks of entering into Franchise Agreements. This should help them to make more informed decisions.

Although the additional disclosure obligations for franchisors are not onerous, they do require franchisors to update their documents before 31 October 2010.

Kate Hocking

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Changes to the Franchising Code of Conduct (Code) have increased franchisors' disclosure obligations

The Code is a mandatory code under the Trade Practices Act 1974 (Cth), that:

• regulates the conduct of franchising participants; and
• aims to ensure that prospective franchisees are sufficiently informed about a franchise before they enter into it.[1]

The Code requires franchisors to provide a disclosure document to prospective franchisees or a franchisee, if the franchisor or the franchisee proposes to renew, extend, or extend the scope of the franchise agreement.

The franchisor must provide that document at least 14 days before the prospective franchisee:

• enters into a franchise agreement (or agrees to enter into a franchise agreement); or
• makes a non-refundable payment to the franchisor or an associate of the franchisor, in connection with a proposed franchise agreement.

The Code is contained in Annexure 1 of the Trade Practices (Industry Codes — Franchising) Regulations 1998 (Regulations). In a response to recent parliamentary inquiries concerning franchising, the Government has passed a number of legislative changes to the Regulations and the Code.

What are the changes to the Code?

The key changes to the Code will require franchisors to make additional disclosures, in the disclosure document, in all of the following areas:

1. Franchise failure

   The franchisor must declare on the first page of the disclosure document that franchising is a business and, like any business, the franchise (or franchisor) could fail during the franchise term, and this could have consequences for the franchisee.

2. Payments to third parties

   The franchisor must disclose details of each recurring or isolated payment payable by the franchisee to someone other than the franchisor or their associate, if:

   • the payment is within the franchisor's knowledge or control; or
   • it is reasonably foreseeable.[2]
3. Unforeseen capital expenditure

   The franchisor must disclose whether the franchisor will, in any way, require the franchisee, to fund unforeseen significant capital expenditure that was not disclosed by the franchisor before the franchisee entered into the franchise agreement.[3]

4. Attribution of legal costs

   The franchisor must disclose whether it will require the franchisee to pay the franchisor"s costs, including legal costs, incurred in dispute resolution, to the franchisee.[4]

5. Unilateral variation[5]

   The franchisor must disclose:

   1. the circumstances in which the franchise agreement may be unilaterally varied by the franchisor;
   2. for any franchise agreement entered into in a financial year commencing on 1 July 2011, 1 July 2012 or 1 July 2013, the circumstances in which the franchisor has unilaterally varied a franchise agreement since July 2010; and
   3. for any franchise agreement entered into after 1 July 2013, the circumstances in which the franchisor has unilaterally varied a franchise agreement in the last 3 years.

   The obligation applies whether the variations result from legislative changes or from a change by the franchisor to the franchise system.

6. Confidentiality

   The franchisor must disclose any confidentiality obligations that will be imposed on the franchisee including details of the matters that the obligation may cover.[6]

7. End of term arrangements

   The franchisor must now include details of the process that will apply in determining arrangements to apply at the end of the franchise agreement including:[7]

   • whether the prospective franchisee will have any options to renew, or extend, or extend the scope of the franchise agreement or enter into a new franchise agreement and, if so, the processes the franchisors will use to determine whether to renew, extend, or extend the scope of the franchise agreement or enter into a new franchise agreement;
   • whether the prospective franchisee will have a right to an exit payment, and if so, how the exit payment will be determined or earned;
   • the arrangements that will apply to unsold stock, marketing material, equipment, and other assets purchased when the franchise agreement was entered into;
   • whether the franchisee will have the right to sell the business at the end of the agreement, and if so, whether the franchisor will have first a right of refusal; and
   • whether the franchisor will consider any significant capital expenditure undertaken by the franchisee during the franchise agreement, in determining the arrangements to apply at the end of the franchise agreement.
8. Transfer of the franchisee"s business to a new franchisee — known as “novation”

   The franchisor must advise whether it will amend (or require the amendment of) the franchise agreement on or before the transfer or novation of the franchise.[8]

   The term 'novation' has been introduced to the Code and is defined as the termination of the franchise and entry into a new franchise with a proposed transferee on the same terms as the terminated franchise.

What are the other changes to the law?

In addition to the changes to the disclosure obligations under the Code, the key changes to the Regulations are summarised below:

1. Clearer rules for acceptable dispute resolution activities — mediation

   The parliamentary inquiry into franchising identified that some parties to a franchise dispute are stalling negotiations and acting to deplete resources of the other party. These actions frustrate the dispute resolution process under the Code.[9] Previously, there was little guidance on what behaviour is regarded as a genuine attempt by a party to resolve a franchise dispute.

   Now, a non-exhaustive list of acceptable dispute resolution behaviour has been added to the Regulations. A party will be taken to be trying to resolve a dispute in a reconciliatory manner, if they:

   • attend and participate in meetings at reasonable times;
   • at the beginning of the mediation process, make the party's intention clear as to what the party is trying to achieve through the mediation process;
   • observe any obligations relating to confidentiality that apply during or after the mediation process;
   • refrain from acting in a way which damages the franchise systems reputations (such as providing inferior goods, services, or support); and
   • adopt a 'business as usual' approach during the dispute: that is, they don't threaten or fail to provide goods, services or support. Again, the concern is to prevent parties from acting in a way that damages the franchise system's reputation.

   The parties are equally liable for the costs of mediation, unless they agree otherwise. [10]

   The 'costs of mediation' include[11]:

   • the cost of the mediator;
   • the cost of room hire; and
   • the costs of any additional input (excluding expert reports) agreed by both parties to be necessary to the conduct of the mediation.
2. Prohibition on release from liability

   A franchise agreement entered into on or after 1 March 2008 must not contain, or require a franchisee to sign, a waiver of any verbal or written representation made by the franchisor.[12]

3. End of term notification[13]

   The franchisor must now notify the franchisee, at least 6 months before the end of the franchise agreement, of the franchisor's decision:

   • to renew or not renew the franchise agreement; or
   • to enter into a new franchise agreement.

   If the term of the franchise agreement is less than 6 months, then the franchisor must notify the franchisee of its decision at least one month before the end of the term of the franchise agreement.

   It is unclear if:

   • if the franchisor needs to provide reasons for the decision; or
   • what the consequences are of a franchisor failing to comply with the statutory timeframes.

What proposed changes were not made?

Good Faith

The changes to the Code do not include a statutory obligation for franchisors and franchisees to deal with one another in good faith (although this was considered).

Instead, by way of compromise, a new clause has been inserted into the Code which preserves and recognises any common law developments on the concept of good faith.[14] This clause provides that nothing in the Code limits any obligation imposed by common law on the parties to a franchise agreement to act in good faith.

When will the changes apply?

Although the Code applies to franchise agreements entered into on, or after, 1 October 1998, the changes to the Code apply to any franchise agreement entered into, renewed, transferred or extended on or after 1 July 2010.

There are no transitional arrangements. Accordingly, any franchisee that signs a franchise agreement on or after 1 July 2010, must have been provided with a disclosure documents that comply with the new Code.

How will the laws effect existing franchise agreements?

Franchisors are required to update their disclosure documents annually within 4 months after the end of financial year. All franchisors must ensure the new changes are incorporated into their updated disclosure documents by 31 October 2010.

You can contact Maddocks (03 9288 0555) for help:

• updating your existing disclosure document;
• updating your franchise agreement; or
• arranging for new documents to be prepared,

More information from Maddocks

For more information, please contact Maddocks (03 9288 0555) and ask for a member of the Commercial Team in Melbourne or Sydney.

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[1] 'Franchising Code of conduct amendments' published by the Australian Competition and Consumer Commission, available at: http://www.accc.gov.au/content/index.phtml/itemId/815467.
[2] See item 13.6A of the Code.
[3] Se item 13A of the Code.
[4] See item 13B of the Code.
[5] See item 17A of the Code.
[6] See 17B of the Code.
[7] See item 17C of the Code.
[8] See item 17D of the Code.
[9] Regulatory Impact Statement, Franchising policy reforms and the Government response to the Joint Committee on Corporations and Financial Services' report on franchising, available at http://www.comlaw.gov.au/.
[10] Subclause 31(2) of the Regulations.
[11] Subclause 31(4) of the Regulations.
[12] See section 16(1A) of the Regulations.
[13] See section 20A of the Regulations.
[14] Clause 23A of the Code