Queensland Law Society

Franchising reforms

Fred Potgieter, Special Counsel for Intellectual Property and Technology at DLA Philips Fox has produced this online article on behalf of the QLS Franchising Law Committee.

Introduction

In the October 2009 Proctor, the QLS Franchising Committee reported on the status of Federal and State Government inquiries into the franchising sector in recent years.

On 5 November the Federal Government announced major changes to the Franchising Code of Conduct (Code) and the Trade Practices Act 1974 (Cth) (Act). The changes are detailed in the Government Response to the report of the Parliamentary Joint Committee on Corporations and Financial Service (Joint Committee) published in December 2008 after investigation and review of the Code. The aim of the changes is to provide greater protection to franchisees. Draft legislation for the amendments will be due early 2010.

In announcing these amendments, the Government also flagged that, in light of the numerous State and Federal inquires over the last four years, there would not be another review until 2013.

What this means for franchisors

As a result of the amendments, franchisors will need to:

  • Ensure that their records are always complete, up to date and accurate because they could be subject to a compliance audit at any time.
  • Ensure that they are able to substantiate any representations in relation to their goods and services as they may be subject to a substantiation notice at any time.
  • Amend their disclosure documents to include a warning that the franchise could fail during the franchise term.
  • Amend their disclosure documents and franchise agreements to deal specifically with end of term arrangements.
  • Notify franchisees no later than 6 months before the end of the term of the franchise agreement whether or not they agree to renew the agreement.
  • Follow the behaviours to be set out in the Code in relation to dispute resolution.

Good Faith Obligation

Whilst accepting the intent of the Joint Committee's proposed express good faith obligation, the Government acknowledged that good faith is still evolving and that a generic good faith obligation will increase uncertainty and, potentially result in adverse commercial consequences for the sector.

The Government instead considered it best to identify specific franchising behaviours that would reasonably be considered to be inappropriate and to implement arrangements and policies to address those in a targeted manner.

At this stage, the Government intends to amend the Code:

  • Specifically in relation to end of term arrangements and dispute resolution.
  • In due course, once an expert panel has consulted and advised on a list of specific good faith behaviours to be included.
  • Note that the Code does not limit any common law requirements of good faith in relation to a franchise agreement.

End of Term

The Government will amend the Code to deal specifically with end of term arrangements for all new franchise agreements entered into after commencement of the amendments. This will require franchisors to consider the following:

  • 'Would the prospective franchisee have any options to renew or extend the agreement beyond the original term? If so, what processes would the franchisor use to determine whether or not to renew or extend the agreement?'
  • 'Information on whether or not the prospective franchisee would be entitled to an exit payment at the end of the term and, if so, how the exit payment will be determined and/or earned.'
  • 'Details on what arrangements would apply to unsold stock and/or equipment at the end of the agreement. For example, would the franchisor buy the stock and/or equipment back at the end of the term? If so, how would price be determined?'
  • 'Details on whether or not the prospective franchisee would have the right to sell the business at the end of the term. If the franchisor would have first right of refusal in any right to sell the business, how would value be determined?'

Further, franchisors will be required to inform franchisees at least six months before the end of the franchise agreement of its decision either to renew or not renew the agreement.

Dispute Resolution

To encourage parties to a dispute to approach the dispute in a reconciliatory manner, the Government will amend the Code to include a non-exhaustive list of behaviours which may impair the effectiveness of a dispute resolution process under the Code.

This list of behaviours will include:

  • Attending and participating in meetings at reasonable times and reasonable locations.
  • Making intentions clear at the outset of a mediation (that is, if the aim is to negotiate an exit arrangement, this should be disclosed).
  • Observing confidentiality obligations during and after the mediation process.
  • Not damaging the franchise brand during the dispute including providing inferior goods, services or support.

Strengthening dispute resolution as a preferred alternative to litigation should be welcomed by the franchising sector.

Expert Panel

In recognition of the need to define specific franchising behaviours to ensure a targeted good faith obligation, the Government will establish an expert panel to report on a list of specified behaviours to be incorporated into the Code that are inappropriate in a franchising arrangement. In creating this list, the expert panel will have particular reference to:

  • Unforeseen capital expenditure.
  • Unilateral contract variation.
  • Attribution of legal costs.
  • Confidentiality agreements.
  • Franchisor-initiated changes to franchise agreements when a franchisee is trying to sell the business.

The panel will consult with franchising and retail tenancy representatives, small business organisations and the ACCC among other interested parties. This panel will also inquire into and report on the need to introduce a list of examples that constitute unconscionable conduct, or a statement of principles in the Act.

Common law requirement

The Government will also amend the Code to provide that nothing in the Code limits any common law requirement of good faith in relation to a franchise agreement to which the Code applies.

Unconscionable conduct

Under the Trade Practices Amendment (Australian Consumer Law) Bill 2009 (Australian Consumer Law), introduced on 24 June 2009, the Government has indicated that it will increase the range of penalties and enforcement of measures available for unfair practices and unconscionable conduct and that these will be available in a franchising context.

Further, the Government has indicated that it will introduce amendments into the unconscionable conduct provisions of the Act to provide:

  • That the terms of a contract, the process of settling a contract, as well as the ongoing behaviour of a franchisor are relevant to a finding of unconscionable conduct.
  • For a specific list of examples that constitute unconscionable conduct, particularly in relation to the franchising sector. This list will be created by the same expert panel that will be advising on the inclusion of specific good faith obligations under the Code.

Penalties

Civil penalties of up to $1.1 million for corporations and $220,000 for individuals will apply to anyone engaged in unconscionable conduct or making false or misleading representations to franchisees.

Strengthened ACCC powers

Random audits

The ACCC will not be required to have any belief about non‑compliance before conducting an audit.

However, the ACCC's audit powers will be restricted to information that is required to be kept under the Code. For example, the ACCC will be able to request a franchisor to produce a copy of its disclosure document.

Any further investigation by the ACCC, if required, would only occur under its existing investigative powers, for example under section 155 of the Act.

Substantiation notices

The ACCC will be able to issue substantiation notices, requiring persons to substantiate any claims they make in promoting their goods or services. These notices will likely be utilised by the ACCC to seek information which will assist in determining whether a contravention of the Code or other codes has occurred.

Public warnings

In addition to its investigative powers, the ACCC will be authorised to publicly 'name and shame' rogue or unscrupulous franchisors.

It is proposed that the written 'public warning' notice, to be introduced under the Australian Consumer Law, will only be made where the ACCC:

  • Have reasonable grounds to suspect that the conduct may constitute a contravention of a provision of the consumer protections provisions of the Act.
  • Is satisfied that one or more persons has suffered, or is likely to suffer detriment as a result of the conduct.
  • Is satisfied that it is in the public interest to issue the notice.

Class actions by ACCC

In addition, where a large number of franchisees are harmed by the behaviour of a franchisor in breach of the Code, the ACCC will be empowered to institute a 'class action' on behalf of 'harmed' franchisees against a franchisor in breach of the Code. It is intended that the ACCC will be allowed to apply for Court orders providing redress to all franchisees without the need for franchisees to be party to the legal proceedings. This could include orders for a person to pay a pecuniary penalty for breach of the unfair practices and unconscionable conduct provisions of the Act.

The reasoning behind the proposed amendment is to assist 'harmed' franchisees unable to afford the cost of instituting legal action against a franchisor for redress.

Other changes

In addition, further minor amendments relevant to the franchising sector and the Code have been proposed, such as:

  • Changing the name of the Office of the Mediation Advisor to the Office of the Franchising Mediation Advisor, to aid the sector's understanding of the role of this office.
  • The form of the Disclosure Document will be amended to include an additional statement on the front page of the disclosure document that franchising is a business and like any other business the franchise (or franchisor) could fail during the franchise term.

Next steps

The Government has indicated that it will release draft legislation in relation to the enforcement package for public consultation early 2010.

The Government has also acknowledged that the franchising sector deserves some "certainty and stability before instigating another review that could result in regulatory changes". At this stage, no further review of the franchising sector or the Code will occur until 2013, where a review of the efficacy of the 1 March 2008 amendments, and any amendments to the Code proposed as part of this response, will be reviewed.

It is worthy to note that the Government did not accept the following recommendations of the Joint Committee at this stage:

  • An online registration system of franchisors.
  • An inclusion of an automatic right of termination for franchisees in the event of franchise failure.
  • The inclusion of a clear statement by franchisors of the liabilities and consequences applying to franchisees in the event of a franchisor failure in disclosure documents.
  • Civil pecuniary penalties for breaches of the Code.

It remains to be seen whether these issues are pursued in future reviews.

What this means for practitioners

Before accepting instructions to provide legal advice to a franchisor, franchisee or franchise sector participant, practitioners should be familiar with the Code and at least the relevant provisions of the Act.

The reforms once introduced will have serious implications and consequently increase practitioners' potential exposure to professional negligence claims when advising clients.

It is expected that the introduction of an expert panel will result in more flexibility and constant changes to behaviours considered unconscionable or in bad faith. This will increase practitioners' responsibility to remain abreast of and familiar with developments when advising clients.

The QLS Franchise Committee will produce a further update once the draft legislation is published for public consultation.

Franchising Committee Chair’s Note

Members involved in franchising may also find these links useful:

Derek Sutherland, Chair of the Franchising Law Committee and Partner at Dibbs Barker