Franchising News - 9 March 2010

Franchising Behaviours

According to the Minister, the Government has accepted the Report’s recommendations on five specific franchising behaviours (as the Expert Panel called them). The recommendations on these behaviours will hopefully avoid the need for a defined obligation of “good faith” not only in the Franchise Code of Conduct ("Code") but also in the Unconscionable Conduct provisions in the Trade Practices Act ("TPA"). The five franchising behaviours are detailed below:

1. Unilateral Variations - Franchise Agreements

The Expert Panel recognised the commercial need for franchisors to unilaterally vary franchise agreements particularly through amendments to their operations manuals. The Expert Panel concluded that it is not appropriate at this time to prohibit unilateral contract variations in the franchising sector. However, franchisors will be required to disclose the following:

• the circumstances under which franchisors can make unilateral variations to their franchise agreements
• details of those instances where the franchisor has unilaterally varied a franchise agreement in the last three financial years.

2. Unforseen Capital Expenditure

The Expert Panel expressed concern that many franchisees are unaware of the ongoing capital expenditure required under their franchise agreement, particularly towards the end of the term. They concluded that franchisors will be required to disclose the following:

• whether there will be significant capital expenditure imposed on the franchisee towards the end of the franchise term, which would be a factor to be considered at the time of renewal and whether such capital expenditure has been a factor in the past
• details of unforseen capital expenditure in those circumstances where the franchisor amends the operations manual.

• whether or not a party is entitled to an exit payment at the end of the term, and if so, how the exit payment is determined
• what arrangements would apply at the end of a franchise agreement to unsold stock or equipment
• does the franchisee have a right to sell the business at the end of the term, whether the franchisor has a right of first refusal and how market value is determined.

3. Sale of a Franchise Business

The Expert Panel recognised the legitimate commercial and regulatory reasons why a franchisor should have the right to amend a franchise agreement on renewal or when the franchisee seeks to sell its franchised business.  However, there should be additional upfront disclosure obligations imposed on a franchisor to detail how and when the seller’s franchise agreement will be amended in the circumstances where the franchisee is seeking to sell its franchise.

4. Legal Costs

The Expert Panel noted that the Code is flawed in two ways when dealing with legal costs. Firstly, the Code provides that parties are equally liable for the costs of mediation unless they agree otherwise. However, there may not be meaningful agreement where an imbalance of bargaining power exists between the franchisor and franchisee. Secondly, the Code also provides that parties must pay for their own costs of attending mediation. However, the Code is not clear on whether “costs” includes costs incurred in preparing for mediation.

Therefore, the Expert Panel supported improved initial disclosure of the cost-attribution of dispute resolution, to enable franchisees to better weigh the risks and rewards of entering a particular franchise system. The Expert Panel was of the view that this type of disclosure should occur early on in the decision making process.

5. Confidentiality Agreements

The Expert Panel recognised the importance of confidentiality agreements in commercial relationships for the protection of intellectual property. According to the Expert Panel, confidentiality agreements are of concern because they may effectively:

• prevent past and present franchisees from openly discussing their franchise experiences with prospective franchisees, frustrating recent amendments to the disclosure regime
• prevent franchisees discussing important matters relating to their arrangements with other franchisees in the franchise system contrary to the intentions of the provision of freedom of association of franchisees and prospective franchisees.

The Expert Panel supported additional disclosure obligations dealing with the categories of information that cannot be discussed with existing and former franchisees. This disclosure could extend to information/circumstances relating to mediation, settlements, intellectual property and trade secrets.

Other Issues

1. Additional Disclosure Document

The Minister has also announced that franchisors will now be asked to provide prospective franchisees with an additional, simple, plain English document which details the franchisees rights and responsibilities. This guide will be additional to the current disclosure requirements under the Code and would emphasise the key costs, benefits and risks of the franchise system.

The Report however, makes no recommendations about the nature, form and content of the document. No mention is made about when the document is to be delivered to the franchisee and whether the franchisee would be required to acknowledge receipt.

It would appear that this document would be something of a “pre-disclosure” document which would explain the general nature of the franchise relationship. The Report suggests that the franchising industry develop the document, taking into consideration the mutual business interests of the franchisors and franchisees.  Although the Expert Panel recommended that this document be voluntary at this stage, its mandatory use has been recommended “if franchisees remain unaware of the nature of the franchise relationship and the potential key costs, benefits, and risks of the franchise business model in general”.

2. Good Faith

As to the question of “good faith”, the Expert Panel has supported the decision of the Government to introduce an express statement into the Code providing that “nothing in the Code limits any common law requirement of good faith” rather than inserting a specific definition of “good faith”. This is consistent with the recent findings of the Joint Committee on the Franchising Code of Conduct and the Senate Economics Committee Inquiry into Unconscionable Conduct, which both advised against a well-defined “good faith” obligation being introduced into legislation.

3. Unconscionable Conduct

With regard to Unconscionable Conduct, the Minister has announced that various sections of the TPA will be clarified to help courts and regulators with enforcement and to assist the public in understanding what is and what is not acceptable behaviour.

The amendments will give the ACCC and the courts greater power to take action against franchisors who bully, harass or coerce others who are in a weaker position.   

•  the courts may examine both the terms of a contract and behaviour during the life of a contract
• the courts may look at systemic conduct or patterns of behaviour in order to determine whether unconscionable conduct has occurred
• there is no need to establish a special disadvantage between the parties (e.g. language difficulties) to prove there has been unconscionable conduct
• that unconscionable conduct under the TPA can be interpreted more broadly than under existing case law.

Conclusion

We expect there will be significant amendments made to the Code, and in particular the disclosure requirements, to ensure all of the Expert Panel’s recommendations are adopted. The Report makes a number of recommendations which will have a significant impact on the franchising sector and franchisors. Although it's currently unclear when exactly amendments will be made to the TPA and the Code, it is highly likely that the Report’s recommendations will be accepted and acted upon in addition to the Government’s own initiatives announced late last year in response to the Code inquiry. Some of these initiatives include:

• random audits of franchise systems to be conducted by the ACCC
• public warnings about rogue franchisors.