Draft consultation complete: One step closer to franchising code reform

 

Introduction

We recently reported on the Government’s response to the Independent Review of the Franchising Code of Conduct (Code). Now, as the brief public consultation period has ended for the Treasury’s Exposure Draft rewrite of national franchising law, the Government is now in the final stages of amending the Code.

The Exposure Draft follows extensive consultation with industry leaders, franchisees and franchisors, including an official review from previous ACCC Deputy Chair Dr Michael Schaper. In this article, we briefly analyse the key elements of the Exposure Draft, and some of the changes (and potential issues) set out in the current drafting.

No Transitional Provisions

The current Code will be repealed on 1 April 2025, with the new Code being operative from that date. However, unlike previous Code updates, this time there are no transitional provisions. Why is this significant? When the current Code is repealed, the current Disclosure Document contained in Annexure 1 of the same will also be repealed and will be replaced with a new Disclosure Document in the form set out in the Exposure Draft (and which is significantly different from the current Disclosure Document).

Unless transitional provisions are inserted into the final version of the new Code, current disclosure documents will need to be updated to comply with the new requirements on and from 1 April 2025.

Expanded Purpose

The purpose of the new Code has been substantially broadened to align with Dr. Schaper’s recommendations. This expanded definition aims to provide clarity of expression to match the policy intent of the Code. However, it remains to be seen what utility this change provides. This change may also have unintended consequences when it comes to litigation, as it is likely Court’s will be asked to determine whether a party is in breach of the “purpose” of the Code.

Increased Civil Penalties

The ‘super penalty’ regime will now cover more situations, including new obligations related to providing a reasonable opportunity for franchisees to obtain a return on investment and compensation for early termination (mentioned in greater detail below). The potential penalties a court could impose include the greater of $10 million, three times the value of the benefit obtained, or 10% of the adjusted turnover for the past 12 months.

Under the current Code, only a small number of clauses were civil penalty provisions. This has been expanded so that nearly every clause which places an obligation on a party to a franchise agreement is a penalty provision. Accordingly, franchisors will need to carefully review these changes, and their current practices, to ensure compliance.

Compensation and Return on Investment

Perhaps the most significant change contemplated by the new Code is the inclusion of the new section 42. This section states that franchisors must not enter into a franchise agreement unless that agreement provides for a buy-back/compensation mechanism if the agreement is not renewed; or is terminated before it expires in circumstances where the franchisor withdraws from the Australian market, rationalises their network, or changes their distribution model.

This requirement (previously applicable only to franchise agreements for motor vehicle dealers) will now apply to all franchise agreements. It is currently unclear as to the extent of ‘rationalising’ or changes to a distribution model that will be required to trigger this section. The insertion of this section has been a cause of great consternation with franchisor stakeholders, who have lobbied the Government heavily against its inclusion. Accordingly, the language of the final draft may differ from the language contained in the Exposure Draft.

Another important change is the insertion of a new section 43. This new section prohibits a franchisor from entering into a franchise agreement unless the agreement provides the franchisee with a “reasonable opportunity to make a return on investment, during the term of the agreement, on any investment required by the franchisor as a part of entering into, or under, the agreement.” Unless further clarification is inserted into this draft provision, our view is that the operation and scope of this clause will be uncertain until such time as it is determined by the courts. For example, what it meant by “return on investment”? Does it imply the achievement of a certain level of profit? If so, what percentage return is acceptable, and will the acceptability of said return vary from franchise system to franchise system, and even within each system?

On a practical level, franchisors must begin examining the length of their initial terms against the costs incurred by a franchisee to set up the business, and whether the term offered allows enough time to give the franchisee an “opportunity” to obtain a return on the initial investment (i.e. the more expensive the initial costs, the longer the initial term will need to be).

Simplified Disclosure Process

The Exposure Draft seeks to simplify the provision of pre-entry disclosure obligations. Existing franchisees can opt out of receiving certain documents if they have, or recently had, another franchise agreement with the franchisor for a similar business. However, the lack of clarity on what constitutes ‘substantially the same’ business may pose challenges. For example, it is unclear whether a stand-alone business is considered the same as a kiosk with a narrower menu.

Ombudsman Powers

The Australian Small Business and Family Enterprise Ombudsman (ASBFEO) will have the power to publicise the names of franchisors who refuse to engage in, or who withdraw from, alternative dispute resolution (ADR) processes. This aligns with Dr. Schaper’s recommendations and aims to encourage franchisors to participate in ADR. Franchisors with legitimate reasons for not engaging in ADR will need to communicate these reasons clearly to avoid being publicly named.

Advisor Certificates

The new Code clarifies that franchisees can sign certificates confirming they have obtained advice from a professional advisor, without needing that actual advisor to sign. This change aims to speed up the execution of franchise documentation by avoiding delays caused by waiting for advisor signatures. The clarification addresses confusion in the Current Code (which does not make it 100% clear that the advisors signature was ever actually required) and should streamline the process of entering into agreements.

Record Keeping

Franchisors must keep all required documents for six years, with civil penalties for non-compliance. This includes documents provided by franchisees and supporting documentation for statements made in disclosure documents. The emphasis on record-keeping practices highlights the importance of maintaining accurate and comprehensive records, and may add significant compliance costs to franchisors.

Marketing Funds

The concept of marketing funds has been expanded to include ‘specific purpose funds,’ which cover any payment arrangement where money is collected from franchisees for a specific common purpose. For example, conference fees pooled together for an annual conference will now be subject to the same stringent auditing requirements as marketing funds. Franchisors will need to ensure these funds are managed and reported on appropriately.