What is a Franchise Agreement?



Australia’s franchising industry is continuously growing. It is also arguably the most heavily regulated in the world.


Franchising is not itself a business, but rather, a way of doing business. A franchisor is someone who has achieved a proven system for success through their unique business model and branding, and has chosen to replicate that system by franchising. A franchisee is someone who has recognised that success and has opted to operate a business under the franchisor’s branding, systems and procedures. The franchisor and franchisee then enter into a Franchise Agreement to set out the terms and conditions of this business relationship.


The key law regulating franchising is the Franchising Code of Conduct (Code). It contains the definition of a “Franchise Agreement” where 4 elements must be present for this to exist:


  1. there is an agreement which is written, oral or implied; and

  2. one person (the franchisor) grants to another person (the franchisee) the right to carry on a business offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor; and

  3. under which the operation of the business will be substantially or materially associated with a trade mark, advertising or a commercial symbol owned, used or licensed by the franchisor or specified by the franchisor; and

  4. under which, before starting or continuing the business, the franchisee must pay or agree to pay the franchisor a fee. This can include an initial capital investment, payment for goods or services, or a royalty fee, but the fee excludes payments for goods or services supplied on a genuine wholesale basis or repayment of a loan.

If it looks like a duck, walks like a duck and quacks like a duck, then it probably is a duck. The same applies to a Franchise Agreement. It doesn’t matter what the contracting parties call the agreement, for example, a Licence Agreement or Distribution Agreement. If the agreement and the business arrangement between the parties meets all 4 criteria under the Code, it will be a Franchise Agreement. When there’s a Franchise Agreement, it will be governed by the Code and certain rules must be complied with.


The Franchising Code of Conduct


The Code regulates the relationship and conduct between franchisors and franchisees towards each other. Compliance with the Code is overseen by the Australian Competition and Consumer Commission (ACCC) who actively monitor and enforce compliance.


It essentially exists to even-out the power imbalance in a franchise relationship. Franchisors have much more power in the relationship, so the Code places limits on this power. At the same time, the Code ensures both franchisors and franchisees act fairly.


The Code endeavours to ensure that a franchisee is made aware that entering a franchise is a significant monetary and long-term commitment. Franchisees must be given some of the key information needed to assist them to make an informed decision as to whether the franchise model is a viable investment.


The Basic Rules About Franchising


There are many do’s and don’ts, obligations and procedures under the Code. Most of these cannot be waived or contracted out of. Some of these key things are as follows:


  1. Franchisors and franchisees must act in good faith in all their dealings with each other. There isn’t a definition of “good faith”, so it’s determined on a case-by-case basis. It includes acting honestly in dealings with each other, not acting arbitrarily, and cooperating to achieve the purpose of the Franchise Agreement. Essentially, franchisors and franchisees must act reasonably and must not engage in bullying behaviour. Importantly, good faith doesn’t restrict either the franchisee or franchisor from acting in their own genuine commercial interests.

  2. Franchisees have a 7 day cooling-off period after entering into a Franchise Agreement or making a non-refundable payment to the franchisor (except on renewals, variations or transfers of existing businesses). This means that franchisees who have a last-minute change of mind or who can’t secure finance can pull out of the deal. It does carry a penalty, with the franchisee being required to compensate the franchisor for a portion of the franchisor’s reasonable costs.

  3. Franchisors must maintain a Disclosure Document in the format prescribed by the Code. This document contains key information about the franchise system including names and contact details for current and former franchisees, all costs a franchisee can expect to incur during the course of the franchise and certain litigation affecting the franchise system. It must be kept current via annual updates (with some exceptions).

  4. All prospective franchisees must be given a current Disclosure Document with a copy of the proposed Franchise Agreement and the Code at least 14 days before entering into a Franchise Agreement. This gives them time to do their due diligence and their own investigations into whether the franchise is the right choice for them.

  5. In order to maintain consistency across the franchise system, franchisors generally place restrictions on the products and services which can be used or sold in a franchisee’s business, including the suppliers a franchisee may use. Clear details of these must be included within the franchisor’s Disclosure Document. This disclosure obligation also extends to any restrictions on the franchisee marketing the products and services of their business online.

  6. A franchisee must give their franchisor a statement about whether or not they obtained independent legal, accounting and business advice before entering into a Franchise Agreement. It’s not mandatory for a franchisee to obtain this advice, but they do need to tell the franchisor a yes or no answer. A franchisor must encourage the franchisee to obtain this advice.

  7. If a franchisor maintains a centralised marketing or advertising fund which franchisees pay a designated levy into, then this fund must be spent on legitimate expenses for marketing the franchise system. Franchisors must be transparent about what expenses the fund is used for and provide franchisees with annual statements.

  8. Franchisors generally have the right to require their franchisees to undertake equipment and store upgrades from time to time. These are known as items of significant capital expenditure. For a franchisor to issue this direction, the expense generally needs to be disclosed in the Disclosure Document, and/or be an expense which will be incurred by a majority of franchisees.

  9. There are strict rules for terminating a Franchise Agreement early:

  • In limited circumstances, a franchisor can immediately terminate a Franchise Agreement. This includes if the franchisee becomes bankrupt/insolvent, acts fraudulently in connection with the franchised business, endangers public health and safety, or simply abandons the franchise.

  • Otherwise, a specific procedure must be followed for a franchisor to terminate. If a franchisee breaches their Franchise Agreement and the franchisor wants to rely on that breach to terminate, franchisors must give written notice setting out what needs to be done to fix the breach, together with a reasonable time to remedy (not longer than 30 days). It’s only if the breach is not remedied accordingly that a franchisor can then terminate the Franchise Agreement because of that breach.

  • On the other hand, the Code doesn’t give franchisees corresponding rights to terminate a Franchise Agreement.

10. Franchisors and franchisees must follow certain processes to resolve disputes that may arise. This includes transparency about what the issue is, working together to resolve the dispute, and failing a resolution, attending mediation. Franchisors can’t make a franchisee pay the franchisor’s costs to resolve the dispute.

Takeaways


Breaches of some provisions of the Code can result in ACCC infringement notices. These are currently $11,100 per breach for companies and $2,200 for individuals involved in the conduct (such as a company director). Court issued penalties for breaches of the Code are currently up to $66,600 in each instance. Multiple breaches can mean multiple infringement notices and penalties.


Compliance with the Code must therefore be taken seriously.


The team at Salerno Law are experienced in acting for both franchisors and franchisees in all aspects of franchising law. Get in contact if you need our assistance.


By Luke McKavanagh

Luke has specialised in franchising law since his admission into practice and has acted for a diverse range of franchisors and franchisees of a variety of franchise systems. He is also an active member of the Queensland Law Society Franchising Law Committee where he keeps on the forefront of the latest developments in laws affecting franchising, and contributes towards submissions to government on topical issues facing the franchising industry.


DISCLAIMER: This article is only meant to give you general information and should not be relied on as legal advice. Speak to one of our lawyers for more information.