Franchising Code of Conduct changes take effect April 1 – are you prepared?

The Australian Government's changes to the Franchising Code of Conduct are set to take effect on April 1.

The changes have significant implications for both franchisors and franchisees, with an explanatory statement detailing the changes.

The new Code is the culmination of several formal reviews, including the Dr Michael Schaper Report, into the regulatory framework for franchising in Australia. The proposed reforms are wide-reaching in part, and the scope and future impact of new provisions will emerge over time.

We explore the changes and what they mean below.

The purpose of the New Code

A starting point is the inclusion of a new definition of its 'Purpose':

"This instrument prescribes a mandatory industry code for the franchising industry. The Code requires franchisors, franchisees and prospective franchisees:

1. to act in good faith towards one another; and
2. to do certain things, and observe certain cooling-off periods, before entering into, renewing, extending, transferring or terminating franchise agreements; and
3. to do certain things in relation to disputes and dispute resolution.

The Code also includes:

1. requirements about the terms of franchise agreements; and
2. particular requirements for new vehicle dealership franchise agreements; and
3. requirements relating to the Franchise Disclosure Register; and
4. civil penalty provisions for contravention of requirements.

The Code also confers functions on the Australian Small Business and Family Enterprise Ombudsman in relation to the Code and confers functions on the Secretary for the administration of the Franchise Disclosure Register."

High level comments on some changes

This article will not canvass all of the changes, some of which are procedural and other minor.

Having said that, the New Code does not adopt the former numbering but labels the previous 'clauses' now as 'sections' (but which do not align with the former numbering). We note there is a comparative table showing Old Law Clauses v New Law Sections at Attachment C of the Explanatory Statement.  

However, there are several significant changes which we will highlight. At the same time, we will reiterate critical obligations which remain.

Also, we will not refer to the particular sections which apply to Motor Vehicle Dealerships. Suffice it to say that where, under the former Motor Vehicle Code, there were provisions particular to that Code, in many instances, these have now been extended to apply across all franchises.

Obligation to act in good faith

That obligation remains. However, it is now re-enforced by making non compliance an offence which attracts up to 600 penalty units, (a penalty unit is currently AUD $330). See S 18 (1)-(5).

At the same time, the qualification remains that:

S 18 (6): "To avoid doubt, the obligation to act in good faith does not prevent a party to a franchise agreement, or a person who proposes to become such a party, from acting in the party's, or the person's, legitimate commercial interests."

Further, importantly, there is the S18 (7) qualification.

S18(7): "To avoid doubt, if a franchise agreement does not:

1. give the franchisee an option to renew the agreement; or
2. allow the franchisee to extend the agreement;
   this does not mean that the franchisor has not acted in good faith in negotiating or giving effect to the agreement."

Disclosure document

This obligation remains to provide a Disclosure Document which strictly complies with the New Code. However, there are going to be changes in content as a result of changes brought about by the New Code.

The new requirements for the Disclosure Document are set out in Schedule 1 to the New Code. For instance, a franchisor will have to provide additional information about whether a franchisor will require the franchisee to undertake significant capital expenditure, including the justification for such expenditure.

On the good news front for franchisors, the previous obligation for franchisors to provide a Key Facts Sheet has been removed and no longer necessary.

New civil penalties

The Explanatory Statement contains a repeated justification for the high increase of sections that will attract civil penalties. "The civil penalty is necessary to promote timely compliance and deter misconduct."

In an attempt to address a perceived need for further compliance, with several sections (where this was not in place under the Old Code), now invoke civil penalties for non-compliance up to 600 penalty units. A penalty unit is currently $330 so the maximum where penalty units apply is $198,000 for each infringement.

Additionally, the New Code adopts a recommendation from the Schaper Report where he proposed an alternative higher penalty regime. This is to apply to a number of sections, being ss 34(1) & (2), 45(2), (3) & (5), 46(2) and 64.

This is provided for in s 17 (2):

1. "(2) The amount of the pecuniary penalty for a contravention of a civil penalty provision referred to in subsection (1) by a body corporate is the greatest of the following:
   • $10,000,000;
   • if the Court can determine the value of the benefit that the body corporate, and any body corporate related to the body corporate, has obtained directly or indirectly and that is reasonably attributable to the contravention – 3 times the value of that benefit;
   • if the Court cannot determine the value of that benefit – 10% of the adjusted turnover of the body corporate during the period of 12 months ending at the end of the month in which the contravention occurred."

There is lack of definition or prescription, so what would constitute "the value of the benefit" and what are the criteria to assess the "adjusted turnover" will produce considerable debate before a Court gives further guidance in the future.

A 'name and shame' power has also been bestowed upon the Australian Small Business and Family Enterprise Ombudsman, which can publicise franchisors who fail to engage in alternative dispute resolution mechanisms provided for under the New Code.

These changes reflect the Code's increasing emphasis placed on alternative dispute resolution and disincentivising litigation.

Specific purpose funds

Whereas the terminology under the Old Code dealt with 'marketing funds', this has been superseded under the New Code with the new term "specific purpose fund".

This is defined in s 6 and covers the situation where a franchisee is required to pay monies for a specified common purpose. S 31 sets out the accounting and reporting obligations upon the franchisor to ensure transparency that the funds are being spent for the specific purpose.

Under the Old Code provisions, there were some areas, such as 'cooperative funds' that arguably fell outside the provisions. The New Code seeks to address these gaps and provide a comprehensive approach to these types of funds.

Disclosure of materially relevant facts

S 34 is another expanded section. It requires the franchisor to provide a franchisee with materially relevant facts that are not included in the Disclosure Document.

This is a section that attracts the higher penalty regime for non-compliance. The reasoning as stated in the Explanatory Statement:

"This is because the information mentioned in section 34 is critical for a prospective franchisee or franchisee to make an informed decision about the franchise agreement and failure on the part of the franchisor to disclose this information can have a significant impact upon a franchisee……This is particularly the case if those updated financial details reveal a significant downturn in the franchisor's position that is not reflected in the disclosure document which was given to the franchisee."

The Explanatory Statement also further seeks to justify the change: "…the higher tier civil penalty reflects the seriousness of this obligation on franchisors and is appropriate to deter misconduct."

End of term arrangements

There are changes to these previous provisions.

Under the New Code, a franchisor must notify the franchisee at least 6 months before the end of term, whether the franchisor will offer a new franchise or extend or not. See S. 36.

Restrictions on Restraint of Trade issues

Restraints of trade against franchisees have also been significantly limited - Ss42 & 67.

Under the new Code, franchisors will be prohibited from entering into any franchise agreements that include a restraint of trade clause that applies if:

"S42 Restraint of trade clause if franchise agreement not renewed or extended

A franchisor must not enter into a franchise agreement that includes (in the agreement, or in another document physically attached to the agreement, or in another document incorporated into the agreement by reference) a restraint of trade clause that would apply if:

1. the franchise agreement expires; and
2. the franchise agreement contained an option for the franchisee to renew or extend the agreement; and
3. before the expiry, the franchisee had given written notice to the franchisor seeking to renew or extend the agreement on substantially the same terms as those:
   • contained in the franchisor's current franchise agreement; and
   • that apply to other franchisees or would apply to a prospective franchisee; and
4. before the expiry, the franchisee met any conditions contained in the franchise agreement that were required to be met by the franchisee to renew or extend the agreement; and
5. immediately before the expiry, the franchisee was not in serious breach of the agreement or any related agreement; and
6. the franchisee had not infringed the intellectual property of, or a confidentiality agreement with, the franchisor during the term of the agreement; and
7. the franchisor did not renew or extend the agreement; and
8. either:
   • the franchisee claimed compensation for goodwill because the agreement was not renewed or extended, but the compensation given was merely a nominal amount and did not provide genuine compensation for goodwill; or
   • the agreement did not allow the franchisee to claim compensation for goodwill in the event that it was not renewed or extended.

Civil penalty: 600 penalty units."

This repeats the former provisions but now includes circumstances where a franchisee has sought to renew a franchise agreement. The drafting of these provisions could be clearer.

Further, this section is now included in the new civil penalties regime.

Compensation for early termination

This arises out of the former Motor Vehicle Dealer code and now applies across all franchises.

A franchisor must not enter into a franchise agreement unless it includes provisions for the for the franchisee to be compensated for early termination of the agreement where the franchisor;

• withdraws from the Australian market;
• rationalises its networks in Australia;
• changes its distribution model in Australia.

This applies where the franchisor terminates the franchise agreement.

Further, the franchiser agreement must specify how the compensation is to be determined, with specific reference to:

• lost profit from direct or indirect revenue;
• unamortised capital expenditure requested by the franchisor;
• loss of opportunity in selling established goodwill; and
• costs of winding up the franchised business.

Reasonable opportunity for a return on investment

The New Code has notably expanded a previous provision which required franchisors of motor vehicle dealerships to provide any franchisees with a 'reasonable opportunity' to make a return on investment in the course of their business.

Now, this obligation applies to all franchisors of all franchisees - S 44.

Termination

The new Code 'termination ' provisions are set out in Ss 54, 55, 56, 57 & 58 & 59

They are very prescriptive and need to be strictly adapted and followed by franchisors.

The new civil penalties regime applies to these sections.

Future considerations

A common theme throughout all of these amendments are the increasing risks imposed on franchisors, particularly with respect to drafting the content of the franchise agreements.

The issues discussed in this article, are at a high level and do not cover the full extent of the changes promulgated by the New Code.

For any assistance understanding the new Code, please contact our Franchising team.

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