Franchising Articles and Tips | Greyson Legal
On this webpage we have collated a range of articles, information, news and tips to assist you on your franchise journey. The content below is for general information only and should not be relied upon as advice. If you require specific legal assistance, please contact Greyson Legal.
Table of Contents
- Franchisor Support
- Marketing Funds
- Franchising and Premises Leasing
- Franchising and Standard Form Contracts
- Franchising and Good Faith
- Franchise Territory Selection and Business Location
- Franchise Advisory Councils
- Franchising and End of Term Arrangements
- Franchise Disclosure Documents
- Sales and Reporting in a Franchising Context
- Can a Franchisor Control the Pricing
at which a Franchisee charges its customers ?
When considering acquiring a franchise, its important to check what support the franchisor will be providing.
The franchise agreement may outline the type of support and the operations manual may go into more detail about the extent of the support.
Misunderstanding about support is an area that can lead to dispute between the franchisor and franchisee, can cause mis-trust and is a contributing factor to franchisee failure and failure of the franchise system as a whole.
Before entering into a franchise, prospective franchisees should check the type of support that the franchisor will be providing.
Information about support may be set out in:
the Franchise Agreement;
the Disclosure Document;
Operations Manual; or
other franchise documentation.
You can clarify the support arrangement directly with the Franchisor or by contacting existing Franchisees within the franchise network and obtaining their feedback on Franchisor support.
Franchisors often hold quarterly, bi-annual or annual meetings with their Franchisees. If you are an existing Franchisee and have concerns about Franchisor support, raising these concerns at the meeting may well be worthwhile. There could be other Franchisees experiencing the same issue.
Those concerns can then be more closely examined and ideas for alleviating the issue discussed at the meeting.
If you have entered into a Franchise Agreement based on representations made to you by the Franchisor about support, and such support is not provided to you as represented, you may have remedies at law such as an action for misleading and deceptive conduct.
Marketing Funds allow for the accumulation of monetary contributions from franchisees into a nominated account.
These funds then assist to pay for broad-scale advertising and promotional activities on behalf of the franchise network.
A Marketing Fund is not compulsory under the Franchising Code of Conduct, but where one is set up - the Franchisor must comply with certain criteria.
The Franchising Code of Conduct regulates the conduct of participants within the franchising industry in Australia.
One element of that regulation relates to “Marketing Funds”.
Under the Code:
A franchisor must maintain a separate bank account for marketing fees and advertising fees contributed by franchisees;
If the Franchisor operates corporate outlets, the Franchisor must pay marketing fees and advertising fees on behalf of each corporate outlet on the same basis as other franchisees;
The funds in the Marketing Fund must be used for legitimate marketing or advertising expenses;
The Franchisor is required to prepare an annual financial statement detailing all of the Marketing Fund’s receipts and expenses for the previous financial year;
This financial statement must be prepared within 4 months after the end of the last financial year; and
The financial statement must be given to each Franchisee within 30 days of the statement being prepared.
In addition, the financial statement must be audited by a registered company auditor within 4 months after the end of the financial year to which it relates. In terms of the auditing requirement, the Code does allow the Franchisor the ability to avoid this auditing obligation if:
75% of Franchisees in Australia, who contribute to the Marketing Fund, have voted to agree that the Franchisor does not have to comply; and
these 75% of Franchisees agree to this within 3 months after the end of the financial year.
It is important that Franchisors ensure they comply with their obligations in relation to Marketing Funds or risk breaching the Code.
Franchising and Premises Leasing
Franchisor as Tenant
Where a franchise system involves use of fixed premises, Franchisors will usually enter into a head lease with the Landlord subject to conditions allowing the Franchisor to offer a sub-lease or licence to occupy to their Franchisees. This method:
- allows the Franchisor to retain control of the site in the event of default by the Franchisee;
- does expose the Franchisor to liability if the Franchisee defaults – the Franchisor would then remain liable to the Landlord for the rent and other obligations;
- would normally involve an arrangement between the Franchisor and Franchisee (as per the Franchise Agreement and other ancillary documents) whereby the Franchisee provides the bank guarantee/security deposit, takes out relevant insurances, is required to meet rent, outgoings and other obligations under the Lease.
Where the fixed premises are retail in nature, the disclosure regime under the Retail Shop Leases Act 1994 (Qld) must also be complied with (in respect of premises in Queensland).
Franchisee as Tenant
In this case:
- if the Franchisee were to default under the Lease, the Franchisee would be directly liable to the Landlord for rent and the other obligations under the Lease;
- the Franchisee would directly provide the security bond/bank guarantee to the Landlord and take out relevant insurances;
- the rent, outgoings and other obligations under the Lease are the sole responsibility of the Franchisee;
- make good obligations would also fall solely to the Franchisee.
The trade off for enabling the Franchisee to directly enter into the Lease with the Landlord is the Franchisor loses control of the site.
A way to get around this is for Franchisor to negotiate “step in” clauses with the Landlord. In the event the Franchisee's lease is terminated, the Franchisor has the option to “step in” to the premises and either continue the franchised business or grant a licence to use the premises to another Franchisee.
Franchising and Standard Form Contracts
The Australian Consumer Law (ACL) is a national, state and territory law which commenced on 1 January 2011.
The ACL is contained in Schedule 2 to the Competition and Consumer Act 2010 (CCA). Part 2-3 of the ACL deals with “Unfair Contract Terms”.
In short, this part is designed to provide statutory protections for consumers where those consumers are required to enter into a contract with another party and the consumer has little or no opportunity to negotiate the terms of the contract with the other party.
Which could be called a "take it or leave it" contract.
These types of contacts can be caught by the “Standard Form Contracts” provisions under Part 2-3 of the ACL.
Under the ACL (apart from certain exceptions), a contract may be deemed a Standard Form Contract if it exhibits one or more of the following characteristics:
one of the parties has all or most of the bargaining power relating to the transaction;
the contract was prepared by one party before any discussion relating to the transaction occurred between the parties;
a party was, in effect, required either to accept or reject the terms of the contract in the form in which they were presented;
a party was not given an effective opportunity to negotiate the terms of the contract;
the terms of the contract did not take into account the specific characteristics of other party or the particular transaction;
the regulations say it is a Standard Form Contract.
Examples of Standard Form Contracts might include:
hire/lease agreements; and
These types of contracts will typically have a standard body of terms and conditions, with perhaps only a few blank spaces for adding names, addresses, signatures, dates and other relevant variable data.
A particular business may use Standard Form Contracts because that business replicates the contract numerous times to end consumers.
Using a standard form maybe more efficient as it minimises the time and cost of producing multiple contracts which are essentially the same.
For businesses who do use Standard Form Contracts, the ACL provides certain consumer protections against terms in those contracts which may be deemed “unfair”.
A term of a contract is likely to be unfair if it:
causes a significant imbalance in the parties' rights and obligations arising under the contract;
is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.
Examples of terms in a Standard Form Contract which may be deemed unfair are those that:
allow one party (but not another) to avoid of limit their obligations;
allow one party (but not the other) to terminate the contract; penalise one party (but not another) for breaching or terminating the contract;
allow one party (but not another) to vary the terms of the contract.
Where the contract is a Standard Form Contract and a particular term is deemed to be unfair by a Court, the offending term will be “void”, although the contract can continue to bind the parties if it is capable of operating without the unfair term.
A Court may also make an order for compensation where a consumer has suffered loss as a result of an unfair term.
Depending on the nature of the contract, the ACCC or ASIC may be able to provide information and guidance for consumers affected by unfair contract terms.
On and from 12 November 2016, the existing unfair contracts provisions for consumers under the ACL was extended to Standard Form Contracts where:
- at least one of the parties is a small business (employs less than 20 staff); and
- the “upfront price payable” under the contract is:
- no more than $300, 000 in a single year; or
- $1 million if the contract is for more than 1 year.
An upfront price payable includes any payments to be provided for the supply, sale or grant under the contract that are disclosed at or before the time the contract is entered into.
The law was introduced to protect small businesses from unfair terms in business-to-business Standard Form Contracts.
Where a small business enters into, varies or renews a Standard Form Contract on or after 12 November 2016, and a term in that Standard Form Contract is deemed to be unfair - that term can be struck out as void.
The franchising industry will be one of the industries the subject of the ACCC’s initial compliance activities after 12 November 2016.
From a franchisor’s perspective, given many franchisors will use contracts (eg. Franchise Agreements) that could well fall into the Standard Form Contract definition under the legislation, there is an onus on franchisors to check their Franchise Agreements do not contain unfair terms.
There is some argument that if a franchisee asks for changes to a Franchise Agreement and the franchisor does enter into legitimate negotiations with the franchisee about such changes, that the Franchise Agreement would not then be classed as a Standard Form Contract (as the parties would have had the opportunity to negotiate the terms). It would then follow that the provisions about Standard Form Contracts under the ACL would not apply.
However, as with any legislative changes, until they are tested in the Courts it can be difficult to specifically identify whether a particular contract is a Standard Form Contract or whether a particular clause in a Franchise Agreement might be deemed unfair.
In terms of the "unfairness" issue, as a general assumption the types of clauses which might be caught as "unfair" are clauses which:
- allow franchisors to terminate the Franchise Agreement without cause;
- allow franchisors to vary the Franchise Agreement unilaterally;
- penalise franchisees;
- require franchisees to provide broad indemnities for franchisors; and
- restrict the ability of franchisees to take action against the franchisor.
We envisage that key aspects in determining whether a particular clause is unfair will include:
- the extent to which a franchisee was given an opportunity to negotiate the terms and conditions in the Franchise Agreement before it entered into the agreement; and
- whether the franchisee obtained independent legal advice before it entered into the agreement.
Franchising and Good Faith
The Franchising Code of Conduct pursuant to the Competition and Consumer (Industry Codes—Franchising) Regulation 2014 regulates the conduct of franchisors and franchisees within the franchising industry in Australia.
One of the ways in which the Code regulates this conduct is through the notion of “good faith”. Clause 6 of the Code requires each party to a franchise agreement to act towards the other party with good faith, within the meaning of the unwritten law [as historically determined by the courts under common law].
Under the Code, this good faith obligation extends to:
- any matter, dealing or dispute relating to the franchise agreement;
- negotiations relating to the agreement; and
- the Code.
In determining whether a particular party has acted in good faith, the Codes states that the Court might consider:
- whether a party acted honestly and not arbitrarily; and
- whether a party cooperated to achieve the purposes of the agreement.
Some examples of conduct which might not be in good faith include:
one party acting for some ulterior motive;
a party fails to have regard to the legitimate interests of the other party;
conduct which is not in pursuit of legitimate commercial / business interests, such as conduct which is strategically motivated to put a franchisee out of business;
an arbitrary / unreasonable exercise of contractual discretion;
conduct which effectively renders the franchisee's interest under the franchise agreement worthless;
failure to give serious and genuine consideration to the other party's position in a negotiation;
deliberate failure to disclosure relevant information;
the purported termination of a franchise agreement by relying on technical or minor breaches in circumstances where the breaches are not the real motive for the termination;
unnecessary withholding of consent to renewals of the franchise agreement or a sale/transfer of the franchised business;
seeking to terminate without first pursuing dispute resolution mechanisms.
A Court can also take into account other matters it considers relevant.
A franchise agreement must not contain a clause that limits or excludes the obligation to act in good faith, and if it does, the clause is of no effect.
However, the obligation to act in good faith does not prevent a party from acting in their legitimate commercial interests. For example, although a franchisor is required to act honestly and cooperatively during the negotiation of a franchise agreement, there is doubt whether a franchisor is obligated to make additions or changes to an agreement which might be requested by a franchisee.
Just because a franchise agreement states the franchisor will not agree to extend the agreement past its end date, does not of itself mean the franchisor has acted in bad faith.
A failure to act in good faith could result in significant penalties under the Code and/or the issue of infringement notices and fines by the ACCC.
Franchise Territory Selection and Business Location
Territory selection has a direct impact on the viability of a franchised business and the Franchise System.
Use of a geographic plan which shows territory area or use of postcodes are common ways to identify a territory. Although this may not necessarily be the best approach.
Too large a territory may result in the territory being under-serviced.
Too small a territory may cause the franchised business to become unviable.
Statistical data including demographics; market surveys; and consultants experienced in this field should be utilised to assist with territory selection (as opposed to just selecting an area on say postcodes alone).
Exclusivity implies the Franchisee being given total control of the territory to the exclusion of other franchisees and the Franchisor.
It can happen with newer franchise systems, however, that the first batch of franchisees are given territories that are just too large for them. This potentially causes issues because the Franchisee is either unwilling or unable to develop the customer base within that territory, perhaps because the Franchisee is satisfied with the customer base it has already achieved.
This can then impact on market penetration of the Franchisor’s brand, product or service.
Franchisor’s maybe able to counter this by setting minimum performance criteria (eg. minimum sales quotes) or set minimum royalty amounts.
As a general rule, the Franchisor has no restriction on granting other franchisees or itself an opportunity to operate a franchised business within a non-exclusive territory.
The difficulty with a non-exclusive territory is how to manage encroachment and cannibalisation within that particular territory.
Exclusivity may not in all circumstances eliminate encroachment either, especially if some franchisees within a system flout the provisions of their Franchise Agreements by seeking customers from within another franchisee’s territory. They may get away with this for a time until the Franchisor or affected Franchisee become aware of the encroachment.
Franchise Agreements do sometimes include provisions allowing the Franchisor to alter the territory, eg. to allow for population growth within the territory.
Generally there will be no restriction on other franchisees or the Franchisor operating within a non-exclusive territory.
Even where the territory is exclusive, there may still be provisions in the Franchise Agreement allowing other franchisees or the Franchisor to operate within the territory. Eg:
Where the Franchisee has breached the Franchise Agreement;
The Nominated Representative or Franchisee has become sick and unable to carry out its obligations;
The Franchisor is permitted to sell its products/services on line;
The Franchisee is not meeting certain performance criteria.
Franchise Agreements do sometimes include provisions allowing the Franchisor to alter the territory, eg. to allow for population growth within the territory.
Generally, there will be no restriction on other franchisees or the Franchisor operating within a non-exclusive territory.
Even where the territory is exclusive, there may still be provisions in the Franchise Agreement allowing other franchisees or the Franchisor to operate within the territory. For example:
- Where the Franchisee has breached the Franchise Agreement;
- The Nominated Representative or Franchisee has become sick and unable to carry out its obligations;
- The Franchisor is permitted to sell its products/services on line; or
- The Franchisee is not meeting certain performance criteria.
Whether an exclusive or non – exclusive territory strategy is the right one for a particular franchise system will depend on the specific circumstances of that brand.
Ultimately, Franchisors should be seeking to achieve the highest possible market share and gross revenue, while balancing this against assisting individual franchisee units to achieve profitability at a level high enough to sustain their businesses and want to stay in the franchise system.
For the majority of businesses which do not have a substantial or total online presence, the physical location of the business remains an important element in the success of a business. A business which is poorly located will have a distinct disadvantage compared with its competitors.
Franchise Advisory Councils
Franchise Advisory Councils (FAC's) are a representative committee elected to act on behalf of all franchisees within a system, much like a union.
The FAC in effect acts as a central mouthpiece for franchisees designed to provide feedback to the franchisor, to contribute ideas, and provide information to the franchisor with a view to improving the franchise system and brand as a whole.
FAC’s can have varying levels of formality or informality.
The FAC typically would meet with the franchisor quarterly or bi-annually.
The committee members in effect act in an advisory or consultative manner with the franchisor.
FAC is based on the understanding that the franchisor would take on board the information or recommendations made by the FAC when the franchisor is determining its strategies for the franchise system.
Topics that may be covered in the FAC meetings could be quite varied and might include, for example:
Supply of goods and services;
Pricing of goods and services;
Plant & equipment needed for the franchised businesses;
Marketing, promotion and advertising;
A well conducted FAC will incorporate a written charter (or By-Laws) by which the FAC operates.
Ultimately, operating a successful FAC that adds value to the system and its stakeholders will depend on sound communications, commitment of the franchisor and the franchisees, the capabilities of the individual FAC members and how well the FAC is structured.
Franchising and End of Term Arrangements
Under the Code, the Franchisor is required, at least 6 months before the end of the term of the Franchise Agreement, to provide written notice to the existing Franchisee as to whether the Franchisor will renew (or not renew) the Franchise Agreement or enter into a new Franchise Agreement.
If the term is less than 6 months, then the notice period is shortened to only 1 month.
The Franchisee also still needs to satisfy any pre-conditions to renewal as set out in the Franchise Agreement.
In addition, the Code prescribes that Franchisors must set out in the Disclosure Document the process to apply at the end of the Franchise Agreement, including:
whether the Franchisor will require the Franchisee to enter into a new Franchise Agreement;
whether the Franchisee will have any options to renew the Franchise Agreement;
if any exit payment is payable to the Franchisee;
what is to happen to unsold stock;
how marketing material is to be dealt with;
what happens to the plant & equipment and any premises fitout at the end of the term;
will the Franchisee be entitled to sell the franchised business at the end of the term;
whether the Franchisor is granted any right of first refusal to acquire the franchised business, and if so, what is the mechanism to determine the market value ?;
what happens to any significant capital expenditure by the Franchisee associated with the franchised business – how will this affect the arrangements to apply at the end of the Franchise Agreement?
It is important to ensure that the Disclosure Document and Franchise Agreement appropriately deal with these issues.
Franchise Disclosure Documents
The purpose of disclosure is to give to a prospective Franchisee entering into a Franchise Agreement (or an existing Franchisee proposing to renew or extend their Franchise Agreement), information to assist the Franchisee to make a reasonably informed decision about the franchise system and the franchised business.
The Code prescribes that a Franchisor must give a current Disclosure Document to:
- a prospective Franchisee at least 14 days before the prospective franchisee enters into the Franchise Agreement or pays a non-refundable payment;
- a Franchisee renewing or extending their franchise, at least 14 days before the renewal or extension is effective.
The Disclosure Document must be prepared and contain the information prescribed by the Code.
The Franchisor must also update its Disclosure Document on an annual basis and provide this to the Franchisee within 4 months after the end of each financial year.
A Franchisee can request a copy of the current Disclosure Document, although only one request is permitted in any 12 month period.
The Code provides that where there are “materially relevant facts” which come into existence after a previous disclosure period, then the Franchisor must inform the Franchisee in writing, within a reasonable time not exceeding 14 days after the Franchisor becomes aware of the fact or matter. Eg. a change in the majority ownership or control of the Franchisor.
Elements of the information to be disclosed include, among others:
financial details of the Franchisor;
operating costs and fees;
contact details of existing and previous Franchisees;
the business experience for the past 10 years of each officer of the Franchisor;
whether there is an exclusive territory;
conditions for renewal; and
default and termination details.
Full and accurate disclosure by the Franchisor is essential to:
enable prospective Franchisees to make informed business decisions; and
to ensure Franchisors do not breach their obligations under the Code.
Sales and Reporting in a Franchising Context
Most franchise systems incorporate processes which rely on a combination of sales data recording and reporting mechanisms. The collection of sales data has a number of uses in a franchise system:
the Franchisor may use such data as a key performance indicator (KPI), for example, the Franchisee maybe required to reach certain minimum sales targets;
where a Franchisor operates a Marketing Fund, the Franchisor may use the data for the purpose of calculating a marketing levy in the form of a percentage (%) of gross of net sales turnover during a specified period;
the Franchisor may also use the data for the purpose of calculating a royalty payment based on a percentage (%) of gross of net sales turnover during a specified period;
the retention of historical sales data can assist with sales forecasts and determining the amount of revenue that will be generated during different periods. This information can be used to formulate specific marketing strategies for different times of the year.
For Franchisors, given the importance sales data may have within a particular franchise system, it is critical to ensure:
Franchisees correctly record the data;
reports provided by Franchisees are completed properly and supplied to the Franchisor in a timely manner;
that Franchisors review the data and reports on a regular basis; and
where anomalies are identified, appropriate attention is given to the issue and a plan of action put in place to address the issue of concern.
Typically, the Franchise Agreement will include a number of provisions which set out a Franchisee’s obligations around this data recording and reporting.
From a Franchisee’s perspective, it is important they understand these obligations as a failure to meet record keeping and reporting requirements will likely result in a breach of the Franchise Agreement, and potentially give the Franchisor a right to terminate the franchise arrangement.
Can a Franchisor Control the Pricing
at which a Franchisee charges its customers ?
Resale Price Maintenance ("RPM") - Minimum Pricing
Generally, RPM occurs where a supplier requires a business not to sell goods below a minimum price that the supplier stipulates. So, in a Franchisor's case it would occur if the Franchisor stipulated that its franchisees could not charge below a minimum amount for the services they provide.
This type of conduct is prohibited under the Competition and Consumer Act 2010 (Cth) ("CCA"). For example, section 48 of the CCA states:- "A corporation or other person shall not engage in the practice of resale price maintenance."
There is scope, however, in limited situations to apply to the Australian Competition and Consumer Commission (ACCC) for authorisation of RPM. But to be successful on such an application it would need to be on public benefit grounds.
Under section 97 of the CCA, a Franchisor can avoid the RPM prohibition by adopting a recommended price strategy in regards to the prices its franchisees charge.
The key issue though, is that the price must be "recommended".
In terms of the CCA, there is no specific section which restricts a Franchisor from adopting a maximum price strategy.
So a Franchisor is permitted to set a maximum price. In deciding at what level to set as the maximum price, Franchisors should keep in mind:
the factors which can impact on price and whether a particular franchisee (say based on location) is able to secure more profit than another franchisee in a different location;
to exercise your decision in good faith and with reasonable cause;
not set maximum prices arbitrarily - meaning, have a thought process and document its reasons behind setting the maximum price;
not to act capriciously, unreasonably or dishonestly in setting maximum prices.