LexisNexis Practical Guidance®

There was no legislation specifically applying to franchising until the introduction of the Franchising Code of Conduct (“the Code”) in 1998. Until then, the law treated the relationship between franchisors and franchisees just like any other contract, and treated each franchised business as a separate business.

The current version of the Franchising Code of Conduct (Sch 1, Competition and Consumer (Industry Codes-Franchising) Regulation 2014 (Cth)) is the pivotal legislation governing franchising in Australia. It was enacted under the Competition and Consumer Act 2010 (Cth). That Act gives it the force of law, and contains the provisions for the enforcement of the Code.

Even before the advent of franchising, trade mark law had long recognised the ownership by one party of a trade mark, the use of which can be licensed to other parties. This includes the concept of licensing a trade mark to different parties to use in different geographical locations. Accordingly, the long-standing trade mark law fits perfectly with the modern franchising business model.

However, many aspects of the law still have not caught up to the franchising model. For example, the Business Names Registration Act 2011 (Cth) requires that the “Entity” carrying on a business under a business name must register that business name. However, in a franchising business model, the franchisor and each of the franchisees are all separate entities, all carrying on business under the same business name. The Act does not accommodate this. Because of the importance franchisors place on their business names, they generally ignore this legislative requirement.

Sections 23 – 27 of the Australian Consumer Law give protection against unfair terms of consumer contracts and “small business contracts”. The Australian Securities and Investments Commission Act 2001 (Cth) contains substantially identical provisions relating to the supply of financial services and financial products.

"Small business contracts" are defined widely enough to catch the vast majority of franchise agreements. This means that many of the terms commonly found in franchise agreements entered into after 12 November 2016 are void. Examples of such unfair terms include provisions to allow the franchisor unilaterally to change the terms of the agreement, to vary the goods or services supplied under the agreement, or the prices for those goods or services.

Sections 558A – 558C of the Fair Work Act 2009 (Cth) make franchisors liable for breaches by their franchisees of workplace laws by their franchisees if the franchisor knew or should have known of such breaches.

Even though franchises form a very important part of the Australian business scene, there is very little other legislation specifically dealing with franchises. In general, the public regard these businesses as being one large business, as they are made up of a number of franchisees all selling substantially identical goods and services in the same manner and under the same trade mark and other marketing material. Certainly, the advertising of franchised businesses treats them as if they were one conglomerate, even though they are legally regulated as separate entities.

See Laws relating to franchising.

However franchises are subject to the same legislation as all other businesses and such legislation may operate differently because of the peculiarities of the franchising structure.

The ACCC is responsible for enforcing compliance with the Competition and Consumer Act 2010 (Cth), including the Code.

The ACCC is flooded with complaints each year, including hundreds of complaints relating to breaches of the Code. It does not have the resources to deal with all of these and, accordingly, it is of little assistance to an individual franchisee seeking to enforce compliance with the Code.

See Australian Competition and Consumer Commission.

The Competition and Consumer Act 2010 (Cth) prohibits “exclusive dealing”. Many of the common practices of franchisors breach these provisions. This includes requiring franchisees to acquire supplies from the franchisor or from suppliers nominated by the franchisor. It also includes directing franchisees not to sell products other than those nominated by the franchisor.

Franchisors may be relieved from the impact of these requirements by:

• •obtaining authorisation from the ACCC for their activities; or
• •notifying the ACCC of the franchisor’s intentions to engage in exclusive dealing. This is by far the more common way of overcoming the problem. Provided that the franchisor lodges such notification at least 14 days before engaging in the relevant conduct, its conduct will not be considered to breach the Act, unless the ACCC takes action. Because of the ACCC’s limited resources, it rarely takes steps to prevent a franchisor from engaging in exclusive dealing.

See Legislative requirements.

The business of a franchisor involves franchisees investing their own capital, working hard in the franchised businesses and making payments to the franchisor, usually including both initial franchise fees and an ongoing percentage of turnover. Accordingly, the franchisor receives payments for a business in which it has not had to invest, and does not have to run. Many franchisors have become very successful in conducting this business model.

However, establishing and operating a successful business as a franchisor is difficult, and many fail.

See Establishing and managing a franchise system.

A key element in conducting a successful franchised network is for all of the franchised businesses to appear to customers to be part of the network. This enables each franchised businesses to attract business based on the reputation of the network, rather than having to build up their own individual goodwill.

To achieve that, the franchisor must supply each business with its trade mark and branding. This often extends to the colour scheme of the business premises, the uniforms of the staff and the appearance of marketing and other documents, such as menus and price lists.

Having a well-known trade mark and branding associated with goods or services for which there is a demand, is the basis of a successful franchisor business.

The key documents required to conduct business as a franchisor are the operating procedure manual referred to below, the disclosure document (see Disclosure requirements) and the franchise agreement (see Drafting the franchise agreement and related documents), as well as contracts with key suppliers.

When running a normal business, management gives instructions to the staff as to how they should do their jobs, and how the business should be conducted. However, the franchisor has no way of directing the franchisee and its staff how to do their jobs and operate the business otherwise than through the franchisor’s contractual relationship with the franchisee. Accordingly, franchise agreements almost always contain provisions directing franchisees to comply with the franchisor’s manual.

It is important for franchisors to draft the manual in as much detail as possible, to ensure that each of the franchised businesses is conducted in the same way, and up to the standards required by the franchisor. The manual should cover not only how the business is conducted, but what goods and services are to be acquired from specified suppliers.

No matter how well the franchisor runs their business, and no matter how detailed is the procedure manual, the success of each individual franchised business is dependent on the individual franchisee. A badly conducted franchised business can damage the reputation and value of the whole network. This is even worse if the franchisee goes broke, or takes proceedings against the franchisor.

Accordingly, operating a successful business as a franchisor involves carefully choosing suitable franchisees, rather than simply appointing franchisees for the sake of receiving their initial franchise fees. Choosing the right franchisees involves interviewing them and checking their documentation to establish that they have what is necessary in terms of:

• •financial resources;
• •physical and intellectual abilities to run the business; and
• •background and experience.

The franchise agreement is a very important document as it governs the close working relationship between the franchisor and franchisee for years into the future.

All of the franchise agreements used by the franchisor should be identical to facilitate management of the franchise system. For this reason, a fair, balanced document is desirable to avoid the franchisees’ solicitors requiring amendments.

The franchise agreement will be frequently referred to by the franchisor in its dealings with franchisees. Accordingly, it is best to draft the franchise agreement in simple, straightforward terms, avoiding long sentences and legal jargon.

Not too much reliance should be placed on precedents. Rather, the document should be drafted to meet the specific requirements of the franchised business, and the franchisor.

The franchise agreement must be drafted so as to meet the requirements of the Franchising Code of Conduct (Sch 1, Competition and Consumer (Industry Codes-Franchising) Regulation 2014 (Cth)). This is not difficult, but requires compliance with the Code. Specific provisions of the Code relating to the drafting of franchise agreements are as follows:

• •Good Faith. Clause 6 of the Code provides that a franchise agreement must not contain a clause that limits or excludes the obligation to act in good faith.
• •Jurisdiction. Clause 21 of the Code provides that a franchise agreement must not contain a clause that requires a franchisee to litigate or mediate in a different state or overseas.
• •Costs. Clause 22 of the Code provides that a franchise agreement must not contain a clause that requires the franchisee to pay to the franchisor costs incurred by the franchisor in relation to settling a dispute under the agreement.
• •Cooling off period. Clause 26 of the Code requires a cooling off period whereby a franchisee can terminate a franchise agreement within 7 days of signing it. While the Code does not specifically state that this should appear in the franchise agreement, it is desirable that it should, so that each party clearly knows where they stand.
• •Association of franchisees. Clause 33 of the Code prohibits any provision in the franchise agreement preventing franchisees from forming or joining an association of franchisees.
• •Release from liability. Clause 20 of the Code bans provisions which give the franchisor a blanket release from liability.
• •Marketing and cooperative funds. Clause 31 of the Code has requirements to ensure that marketing funds are not misspent.
• •Dispute resolution. Clause 34 of the Code requires the franchise agreement to include a complaint handling procedure. See Dispute resolution.

See Drafting the franchise agreement.

The essence of franchising is that a franchisor grants a licence to the franchisee to use the franchisor’s intellectual property in conducting the business. Accordingly, the franchisor’s intellectual property is an essential element of the conduct of any franchised business. The term “intellectual property”, in the context of franchising is used to mean:

• •patents;
• •designs;
• •trade marks;
• •copyright;
• •business names;
• •company names; and
• •know-how.

However, from a legal point of view, business names, company names and know-how are not intellectual property, as they are not property capable of being owned.

See Protecting the franchisor’s intellectual property.

The most important intellectual property involved in almost any franchise is the trade mark under which the franchised business will operate. Indeed, "use of a trade mark, advertising or a commercial symbol" is an essential element in the pivotal definition of "franchise agreement" in cl 5 of the Franchising Code of Conduct.

Although it is possible to conduct a business under an unregistered trade mark, it is essential that the franchisor’s trade mark should be registered under the Trade Marks Act 1995 (Cth). Otherwise, franchisees will place very little value on the grant of the franchise.

Trade marks are registered in one or more of the 45 categories listed in Sch 1 of the Trade Marks Regulations 1995 (Cth).

The registration and use of business names is governed by the Business Names Registration Act 2011 (Cth).

Most franchised businesses are operated under a business name provided by the franchisor. While one party can register a trade mark and license its use to another party, the Business Names Registration Act 2011 (Cth) has no such system. The Act requires that the party carrying on the business must register the business name. Accordingly, in theory, each franchisee should register the name of the business, even if that name was provided by the franchisor. In practice, franchisors insist on retaining everything they regard as intellectual property including business names and company names, even though these are not property.

Company names are governed by the Corporations Act 2001 (Cth). Like business names, they are not property and, accordingly, cannot be owned by the franchisor and licensed to a franchisee. However, there is no legal requirement that the company name should be the same as the name under which the business is operated. Accordingly, the problem can easily be overcome by not including any name associated with the franchisor in the name of the franchisee company, but with the franchisee trading under a business name associated with the franchise.

The definition of franchise agreement in the Franchising Code of Conduct includes providing the franchisee the right to use “a system or marketing plan substantially determined, controlled or suggested” by the franchisor or an associate of the franchisor. Generally, this is incorporated into a manual supplied to the franchisee, setting out how the business should be conducted, in considerable detail.

While the words used in the manual are protected by copyright law, the ideas are not. Accordingly, while the franchisor regards its systems and marketing plans as intellectual property, they are not property. They can only be protected by ensuring that the manual is only provided to people who have agreed to maintain its confidentiality.

Like know-how, confidential information is not property and cannot be sold or licensed like copyright. However, confidential information, such as a client database, can be a valuable part of a franchised business. It is best protected by agreements between the disclosing party and the recipient where the recipient acknowledges that the information is confidential, and agrees not to use or disclose it, otherwise than as authorised by the disclosing party.

While all franchise agreements are licences, not all licence agreements are franchise agreements.

There is a common perception in the business community that carrying on business as a franchisor involves enormous legal complication and expense. For this reason, many companies try to avoid having to comply with the Franchising Code of Conduct, by claiming that their business model involves licensing, not franchising. However, the definition of “franchise agreement” in cl 5 of the Franchising Code of Conduct is so wide that most of these licence agreements are, in fact, franchise agreements within the meaning of the Code.

Section 26 of the Trade Marks Act 1995 (Cth) refers to trade marks being used by an “authorised user”. This is the legislative basis which enables trade marks to be owned by one party and licensed to another.

Many statutes require licences to conduct businesses, eg selling real estate or liquor. These statutes do not allow one person to hold the licence, then to grant a licence to another person to conduct business. The Australian Business Licence and Information Service (ABLIS) is an online service designed to find all the local, state and federal licences, registrations and permits that a business needs.

See Licensing the franchisor’s intellectual property.

The primary rationale for becoming a franchisee is that it involves acquiring a ready-made business, which already has goodwill associated with its trade mark, and has a clearly defined business system, including a source of supply of products and a detailed manual as to how to operate the business. This advantage needs to be weighed up against the disadvantages. These include the requirement to pay initial and ongoing franchise fees, and the fact that the franchisor remains the real owner of the goodwill of the business.

The disclosure document which the franchisor is required to provide prior to the signing of a franchise agreement can be an important part of evaluating whether to acquire the franchised business. The most important points to look for in the disclosure document are as follows:

• •The franchisor’s experience. Long experience as a franchisor, combined with absence of litigation, and favourable reports from other franchisees is a good basis for trusting a franchisor.
• •Litigation. The Franchising Code of Conduct contains detailed provisions for the supply of information about current and completed litigation against the franchisor or any of its directors relevant to their conduct of the franchising business.
• •Other franchisees. The disclosure document is required to include information about current and previous franchisees, including their contact details. Contacting these other franchisees can be an important part of evaluating a franchise opportunity.

Sometimes, the most important red light in a disclosure document is not what it says, but what it does not say. A franchisor with a poor record or relationship with its franchisees may seek to avoid disclosure by inserting statements such as, “This information is on our website” or “This information is available on request”. Any reluctance by a franchisor to disclose any of the information referred to above should be viewed with deep suspicion.

Consideration of the franchise agreement is also an important part of evaluating a franchise opportunity. Franchise agreements are almost always heavily one-sided in favour of the franchisor, and franchisors are reluctant to negotiate amendments. As this relates to almost all franchise agreements, it should not necessarily discourage the franchisee. Important points to look for are as follows:

• •The term of the franchise agreement, including any options. This is important as, once the franchise period expires, the franchisee is left with nothing, unless a franchisor agrees to grant a further period.
• •Restrictions on transfer of the franchise. Franchisees regularly sell their businesses. The Franchising Code of Conduct provides that the franchisor cannot unreasonably withhold its consent. However, some franchise agreements place requirements upon such transfers, including payment to the franchisor of part of the price of sale of goodwill.

Clause 10 of the Code provides that the franchisee must provide a statement as to their understanding of the disclosure document and the Code before the franchise agreement is entered into, and before any non-refundable payment is made. Clause 26 of the Code provides for a cooling off period of seven days from entering the franchise agreement, or making a payment under the franchise agreement, whichever is earlier.

See Legal and commercial issues for franchisees.

In addition to the usual complex issues that arise in relation to the sale and purchase of a business, transferring a franchised business also involves transferring the franchise agreement, and complying with the other requirements of the Franchising Code of Conduct referred to below.

There are two ways to transfer a franchise agreement:

• •direct transfer, with the consent of the franchisor; or
• •novation, involving the vendor terminating the existing agreement and the purchaser entering into a new one.

Clause 9 of the Code requires the franchisor to give disclosure to the purchaser of the franchised business, in the same way as if that purchaser were taking a fresh franchise from the franchisor. However, cl 26(2) of the Code provides that there are no cooling off rights under the Code for the transfer or novation of an existing franchise agreement.

The sale of business often involves transfer of the lease of the premises where the business is conducted. For franchised businesses, the arrangement is often that the franchisor leases the premises from the building owner, and subleases or licenses them to the franchisee. Accordingly, sale of a franchised business will often include transfer of both the franchise agreement and the lease from the franchisor.

See Buying and selling a franchise.

Under the Franchising Code of Conduct (Sch 1 of the Competition and Consumer (Industry Codes-Franchising) Regulation 2014 (Cth)), certain documents must be disclosed to potential franchisees at least 14 days before they enter into a franchise agreement, or make a non-refundable payment to the franchisor. A copy of the disclosure document must also be given to existing franchisees on request, provided that such requests are not made more often than once in every 12 month period.

Under cl 6 of the Code, franchisors are required to maintain a disclosure document, including the accounts of the franchisor.

The Code sets out very detailed requirements for the disclosure document even including the headings and format which must be used. The forms required for disclosure are set out in Annex 1 of the Code.

See Disclosure requirements.

Clause 9 of the Code also requires disclosure of other documents to prospective franchisees.

• •the proposed franchise agreement; and
• •a copy of the Code.

A copy of these documents must be provided at least 14 days before the date on which the franchise agreement is signed or, if they are not available at that time, when they become available.

Clause 11 also requires that an information statement in the form set out in annex 2 of the Code be provided to prospective franchisees as soon as practicable after they formally apply or express an interest in acquiring a franchised business.

Often, the franchising structure will involve a master franchisor for the whole of Australia, with subfranchisors for each state or other region. Under cl 7 of the Code, there is no requirement for a master franchisor to give any disclosure. The disclosure that is required by the Code is by the franchisor which is dealing directly with the proposed franchisee.

Clause 9(6) of the Code requires franchisors to update their current disclosure documents within four months of the end of each financial year. This would include annexing an updated set of the franchisor’s accounts.

Clause 17 of the Code requires disclosure of any changes in ownership of the franchisor or any litigation against the franchisor or any of its directors, which is not mentioned in the disclosure document.

Clause 22 of the Code also requires the disclosure document to disclose any of the matters referred to in cl 17 of the Code that have changed between the date the disclosure document and the date that it is provided to the prospective franchisee.

Like any breach of the Code, failure to give disclosure gives the courts the wide powers under Pt IV of the Competition and Consumer Act 2010 (Cth).

The requirements of the Code in relation to the disclosure of litigation are stronger than in relation to disclosure of any other matter. Disclosure is required by annex 1 and by the Code itself.

The Code and the annex 1 require virtually all litigation relevant to the franchise to be disclosed, no matter how weak the claims against the franchisor may be. This includes both civil and criminal proceedings.

Disclosure is also required of any judgment in the previous five years relating to any of the litigation referred to above. This is not limited to judgments in which the franchisor lost.

Disclosure is required of the names of the parties, the court or tribunal, the case number and the nature of the proceedings.

See Disclosure of litigation.

Most disputes between franchisors and franchisees involved allegations by the franchisee that they were misled by the disclosure document, or by other representations by the franchisor. These claims can involve breaches of the Franchising Code of Conduct (Sch 1, Competition and Consumer (Industry Codes-Franchising) Regulation 2014 (Cth)) and the Australian Consumer Law.

See Franchising disputes.

Section 51AD of the Competition and Consumer Act 2010 (Cth) provides that any breach of the Code constitutes a breach of the Act. This enables the courts to apply the very wide remedies under Pt IV of the Act. This includes damages, injunctions, and has been held even to extend to inserting a new provision into a franchise agreement.

A large proportion of disputes between franchisors and franchisees include an allegation that the franchisor engaged in deceptive conduct in breach of s 18 of the Australian Consumer Law. This section, and s 52 of the Trade Practices Act 1974 (Cth), which it replaced have generated much litigation. The authorities show that the section is interpreted widely. The defendant can be found guilty of misleading and deceptive conduct even if they are silent about a relevant matter, and even if they are not aware that their conduct is deceptive. A franchisor can be sued for inaccurate representations about future matters, if they cannot show that they had a reasonable basis for making such representations.

Many disputes between franchisor and franchisee involve allegations that the franchisor misled the franchisee as follows:

• •failure to provide a disclosure as required by the Code;
• •inaccurate projection of earnings;
• •understated cost of establishing the franchise; and
• •withholding relevant information.

These are generally simpler disputes where a franchisor is claiming a failure to pay money, such as franchise fees or payment for products.

Franchise agreements generally give franchisors wide powers to terminate the franchise agreement if the franchisee defaults. Franchisors occasionally need to take proceedings against franchisees to prevent them from continuing to carry on the franchised business, or a similar business in competition with the franchisor.

Disputes can be resolved by direct negotiation, mediation, arbitration or litigation.

Part 4 of the Code is headed "Resolving disputes". Clause 34 prescribes that a franchise agreement must provide for a complaint handling procedure as set out in cll 38 and 39 of the Code. However, this provision is unnecessary, as cll 40 and 41 of the Code, which are in identical terms to cll 38 and 39 apply regardless of the provisions of any franchise agreement. These contain a requirement to serve a notice of dispute under cll 38(1) and 40(1). They set out a procedure for mediation, but cl 42(3) gives either party the right to terminate the mediation process at any time after 30 days from the beginning of the mediation. Clause 37 also gives either party the right to commence proceedings, regardless of the mediation, at any time they wish. Part 4 says nothing about resolving disputes in any other way. Accordingly, the Code gives very little assistance as to how to resolve disputes.

Mediation is almost always faster and cheaper than litigation, and allows the parties to negotiate a resolution they can live with, rather than having a solution imposed on them by a court or an arbitrator. From a franchisor’s point of view, mediations also have the advantage that they do not require disclosure to current and prospective franchisees, whereas virtually every form of litigation, including arbitration does.

This gives an indirect benefit to franchisees, as it makes franchisors more willing to be reasonable at mediation, to avoid having to give disclosure if the matter is not settled, and proceeds to litigation.

Arbitration gives virtually none of the benefits of mediation. It is quicker than litigation, but slower than mediation and is no cheaper than litigation.

This is often one-sided, with a well-resourced franchisor seeking to protect its franchising network, against a franchisee whose resources have been depleted by the subject matter of the dispute. However, otherwise, there is nothing about litigating a franchising dispute that is different from litigating any other dispute.

Mediation is as much an exercise in psychology as legal practice. It involves each party having the opportunity to ventilate their feelings, by the lawyers and often the parties themselves saying whatever they wish to say. Even though the mediator makes no determinations as to who is right or wrong, this process makes the parties more willing to put their feelings aside and negotiate a commercial resolution than if they were negotiating directly without a mediator.

Clauses 38(4) and 40(4) of the Code require a complainant to give written notice to the other of the dispute in a prescribed form, and states that the parties must then try to resolve the dispute and not refer it to a mediator for three weeks after commencing this process.

Clauses 38 and 40 allow either party to ask the mediation advisor to appoint a mediator. Clause 45 of the Code provides that the Mediation Advisor shall appoint a mediator, if the parties cannot agree themselves. The Mediation Advisor is a federal public servant, who can be contacted on the Internet.

The federal government and the governments of Western Australia, Victoria, New South Wales and South Australia have each appointed Small Business Commissioners whose roles include assisting small businesses to resolve disputes. The Small Business Commissioners in New South Wales, Victoria and South Australia provide inexpensive mediation services.

See Mediation.