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Franchisors take care! Further penalties and obligations under the Franchising Code for 2021 (part 2)

15 December 2020

#Corporate & Commercial Law, #Competition & Consumer Law

Published by:

Friedrich Kuepper, Amy Hancell

Franchisors take care! Further penalties and obligations under the Franchising Code for 2021 (part 2)

The federal government recently released an exposure draft of changes to the Franchising Code of Conduct (Code). The proposed changes are in response to the Parliamentary Joint Committee’s Fairness in Franchising Report and seek to improve protections for, and information available to, franchisees.

If enacted, the Code will rebalance franchise arrangements in favour of the franchisee and franchisors will face increased obligations and restrictions. Further, for breaches of the Code that carry a civil penalty, franchisors may be exposed to penalties at double the current rate (from 300 to 600 penalty units, currently at $133,200).

In the first part of this series here, we reviewed the likely effect on franchisor’s disclosure obligations and the increase in penalties for breaches of the Code.

In this second part of the series, we examine how the proposed changes may impact on the operation of the franchised business system, termination rights and end of term arrangements and dispute resolution under franchise agreements.

Operation of the franchised business system

Under the exposure draft, a number of changes are proposed which may be likely to affect how franchisors conduct their franchised business system. The proposed changes include:

  • restriction on passing on legal costs – it is currently a common practice for franchisors to pass on legal costs to franchisees, including for preparing and issuing franchise documents, as well as other matters such as enforcement. Under the exposure draft code, franchisors will be prohibited from including a term in the franchise agreement to pass on any legal costs to franchisees under the franchise agreement. Notably, a franchisor who breaches this provision may be liable for a civil pecuniary penalty. However, a specific exemption is also included and franchisors may still pass on certain initial costs if correctly identified, defined and specified in the franchise agreement
  • retrospective variation – franchisors will not be able to retrospectively vary the franchise agreement terms unless the franchisee or a majority of the affected franchisees agree to the change
  • marketing funds – the requirements related to marketing funds will be expanded to master franchisors, and civil pecuniary penalties may apply to breaches of the management and use of marketing funds. This is particularly important in a context where the Australian Competition and Consumer Commissions has shown a willingness to enforce provisions of the Code against franchisors in respect of marketing funds – for example, the 2019 decision by the Federal Court against the franchisor Ultra Tune, which we discussed here, emphasised the importance of providing “sufficient detail” in respect of marketing fund statements.

Dispute resolution processes

The proposed amendments are also aimed at strengthening the dispute resolution options available to franchisees. The franchising dispute resolution advisor functions will be delegated to the Australian Small Business and Family Enterprise Ombudsman, who will assist in all disputes regardless of whether they fall within the definition of a ‘small business’.

Voluntary binding arbitration is also proposed for franchisors and franchisees, as well as multi-party dispute resolution, which will allow franchisees to come together as a group to resolve their disputes with the franchisor. This may have significant implications for larger franchisors dealing with franchisee associations. If the dispute resolution practitioner decides it is appropriate to do so, the franchisor will be unable to refuse to take part in a multi-party dispute resolution.

Ending the franchising relationship

The draft also proposes changes to the Code which will provide franchisees expanded rights and opportunities to end the franchise relationship, including:

  • cooling-off period – the period in which the franchisee can terminate the franchise agreement following entry into it, or making any payment under it, will be extended from seven days to 14 days. The cooling-off period also expressly extends to franchisees who enter the system through a transfer from an existing franchisee. Further, if it is proposed before entry into the franchise agreement that the franchisor (or its associate) leases or grants a right of occupancy to the franchisee during the term of the franchise agreement, then effectively a new 14-day cooling-off period will apply in respect of each of the following events:
    • the franchisee receives a document setting out the terms of a proposed lease or right from the franchisor or associate
    • if the franchisee does not receive a document setting out the terms of the proposed lease or right substantially identical to the actual terms of the lease or right after entering into the lease or being granted the right.
  • early exit – franchisees will be able to formally give notice to franchisors proposing early termination, to which franchisors must provide a written response within 28 days. If franchisors refuse to agree to terminate on the terms proposed, they must provide reasons for the refusal
  • immediate termination – significantly, a franchisor’s right to immediately terminate the franchise agreement in ‘special circumstances’ will be substantially restricted. Where the franchise agreement gives the franchisor power to terminate in any of the special circumstances, franchisors will be required to give seven days’ written notice of the proposed termination and the grounds for termination. If the franchisee argues against this termination and commences dispute resolution, the dispute resolution practitioner can freeze this seven day notice period awaiting the outcome of the resolution process. However, if the franchisee may endanger public health or safety or acted fraudulently, the franchisor can still stop the franchisee’s operation of the franchised business while the proceedings are underway
  • restraint of trade – the protections of a franchisee against restraint of trade clauses under clause 23 of the Code will be strengthened such that, where a franchise agreement is not extended and a franchisee is not able to claim compensation for goodwill, a restraint of trade clause under a franchise agreement may be unenforceable, if (amongst other things) the franchisee is not in serious breach of the agreement.

Doubled penalties

The maximum penalty for a breach of the Code is proposed to increase from $66,600 to $133,200.

What does this mean for you?

If the updates to the Code proceed, franchisors will need to make considerable changes to their documents and policies to ensure compliance. The exposure draft may be viewed in full here.

Key takeaways

Franchisors will need to be aware of the proposed amendments and be prepared to update their systems, documents and policies to ensure compliance before 1 July 2021. In particular, franchisors will need to ensure they do not:

  • pass on franchisor legal costs to franchisees other than in permitted exceptions
  • seek to make retrospective variations to the agreement without consent
  • breach any provision in relation to the management and use of marketing funds.

Also, franchisors need to consider how to approach disputes and early termination having regard to the application of:

  • the new enhanced resolution processes
  • the expanded cooling-off rights of franchisees to end the franchise relationship early
  • the ability to enforce restraints of trade
  • requirements to respond to requests by franchisees to an early exit
  • mandatory notice requirements for franchisors seeking to terminate on special grounds, where currently such termination may be undertaken with immediate effect.

If you require assistance with updating your systems, documents and policies to comply with these proposed changes, please contact our team.

Authors: Trent Taylor, Friedrich Kuepper & Amy Hancell

The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

Friedrich Kuepper, Amy Hancell

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