Franchises are everywhere – from fast-food chains like Subway – to fitness companies like Anytime Fitness. Franchises are understandably enticing because you are purchasing rights in a company which has already built up a solid reputation. However, it is important to understand the implications of a franchise agreement, as franchises come with unique risks that would not be involved if you were to start your own business from scratch.
Key Documents
People who are new to franchising may find franchise agreements and associated documents to be quite daunting. Having a good understanding of these documents, and the rights and obligations they create for the franchisor and franchisee, is crucial to ensure that the franchise runs smoothly.
Key documents include:
Franchise Agreement
A franchise agreement is a contract under which:
- the franchisor grants the franchisee the right to carry on its business and supply goods or services under a marketing plan or system;
- the franchisor grants the franchisee the right to use its business name or a particular trademark;
- the franchisee is required to pay a sum to the franchisor before starting the business (there is usually an ongoing fee as well); and
- other important terms are agreed upon.
A franchise agreement can be made verbally or in writing[1], however we strongly recommend that franchise agreements be made in writing to avoid confusion between the franchisor and franchisee.
Operations manuals
Operations manuals provide details about how the franchise should be run. While an operations manual is not a legal document by itself, certain terms of the operations manual may be made binding if they are referred to in the franchise agreement
The operations manual may outline:
- products and suppliers the franchisee should use;
- pricing and marketing strategies the franchisee should implement;
- reporting, payroll or accounting requirements; and
- performance targets the franchisee must meet.
Disclosure Document
Under the Franchising Code of Conduct (Competition and Consumer (Industry Codes – Franchising) Regulation 2014), franchisors are required to provide a disclosure document to prospective franchisors[2]. The disclosure document must be set out in the prescribed form and will contain valuable information about the franchisor and its business structure.
Among several other things, a disclosure statement must include:
- any litigation the franchisor is currently facing relating to dishonesty, fraud or breach of franchise agreement[3];
- any intellectual property owned by the franchisor and restrictions on its use[4];
- all fixed and variable fees the franchisee will be required to pay over the course of the franchise agreement[5]; and
- financial reports of the franchisor for the last two years[6].
It is important to note that the Franchising Code of Conduct does not apply to agreements:
- entered into before 1 October 1998 (unless they have been extended, renewed or transferred on or after that date[7];
- where a mandatory industry code applies instead (e.g. the Horticulture Code of Conduct[8]);[9]
- where the franchisor provides goods and services, and the franchisee has been supplying goods or services that are substantially the same for at least 2 years prior to entering into the agreement, and sale of goods or services provided by the franchisee is likely to make up less than 20% of the franchisee’s gross turnover.[10]
Information Statement
Under the Franchising Code of Conduct, franchisors must provide an information statement to anyone who expresses interest in, or formally applies to, purchase a franchise[11]. The information statement provides general information about franchising and helps prospective franchisors to consider the risks and rewards associated with franchising.
Lease
Most franchises require a premises to operate. These premises are usually leased.
In most cases, the franchisor will hold the lease and then:
- sub-lease the premises to the franchisee; or
- grant the franchisee a licence to occupy the premises
Franchisors usually want to hold the lease as it allows them to exercise more control over the premises, and it eliminates the fear that the franchisee could abandon the franchisor and trade independently from their own premises.
Alternatively, if the franchisee wishes to hold the lease, many franchise agreements require the franchisee to seek the franchisor’s approval of the premises, usually so that the franchisor will can ensure that the premises is suitable for carrying out their business.
Regardless of whether you are a lessee or a sub-lessee, your lease should contain the following terms
- the address of the premises;
- the commencement date and duration of the lease;
- options for terms of renewal of the lease;
- how much your rent is and when it is due;
- how much your security deposit is;
- what the outgoings are and who is liable for paying them;
- how much the property is going to be insured for; and
- whether you are required to carry out any refurbishment or renovation work during the term of your lease
Vendor finance agreement
Vendor finance is where the franchisor provides funding to the franchisee for the initial purchase of a franchise. The franchisee will pay some money upfront and pay the balance (plus interest) by installments to the franchisor over an agreed time period.
Vendor finance agreements are complicated and should be drafted by a lawyer, however, they should generally include:
- how much is being borrowed;
- what the interest rate is;
- when installments are due; and
- what the loan period is.
Potential risks
As experts in dispute resolution, Slater and Gordon has seen the negative situations that can arise out of franchising. If you are interested in buying a franchise, you should be aware of the following pitfalls:
Being unaware of the 'cooling-off' period
Under the Franchising Code of Conduct, new franchisees have 7 days from signing the franchise agreement or paying a fee (whichever comes first), to consider whether they have made the right decision.
If the franchisee decides within the cooling-off period that they do not wish to proceed with the agreement, the franchisor must refund any money paid to them within 14 days, less money paid for ‘reasonable expenses’.
It is important to note that the cooling-off period does not apply to renewals, extensions or transfers of existing franchises.
Difficulty selling the franchise
If you no longer wish to run your franchise, selling or transferring it to someone else could be more difficult than anticipated. Your franchise agreement may place restrictions the sale or transfer of the franchise, for example:
- the franchisor may have the right of first refusal meaning the franchisee must first offer to sell the franchise back to the franchisor;
- the franchisor may retain an assignment fee upon sale or transfer (either a set amount or a percentage of the sale price);
- the premises and/or equipment may need to be refurbished or upgraded before sale;
- the buyer may need to meet the franchisor’s selection criteria; or
- the buyer may need to complete the franchisor’s training program.
'Churning'
According to the Australian Competition and Consumer Commission, churning is:
the repeated selling of a franchise site by a franchisor in circumstances where the franchisor would be reasonably aware that the site is unlikely to be successful, regardless of the individual skills and efforts of the franchisee.
Churning is not expressly prohibited under the Franchising Code of Conduct or the Competition and Consumer Act 2010 (Cth), however there have been instances where a franchisor’s conduct has been found to be misleading and deceptive. For example, a franchisor was found to have engaged in misleading and deceptive conduct by representing that a franchisee could make $5,000 in revenue each month after 210 days if he purchased a $24,000 cleaning franchise [13]. The franchisor did not have reasonable grounds for making the representation because he did not have sufficient volumes of cleaning work to supply the franchisee [14].
Termination
A franchise agreement may allow a franchisor to terminate the agreement even if you have not breached any terms of the agreement. Some franchise agreements do not allow you to recover the amount you paid for the franchise and you are essentially left with nothing.
If the franchisor seeks to terminate the franchise agreement because it alleges that you have breached the franchise agreement, the franchisor is required to provide you with a notice in writing with details of the breach, what is required from you to rectify it and a reasonable timeframe to rectify the breach. If you do not rectify the breach within this timeframe, the franchise agreement may then be terminated by the franchisor.
Please note that in cases of extreme breaches, the franchisor is not required to give you this notice, including but not limited to situations where the company is insolvent, you are convicted of a serious offence or you operate the business in a way that endangers public health or safety.
Assistance from the franchisor
Even though it is in a franchisor’s interests to assist you with successfully running your franchise, franchisors are not always forthcoming with assistance. Further, the franchisor may be able to compete with you with other franchises owned by franchisor or by online trading. This can result in you struggling to maintain the franchise and can cause your franchise to fail, meaning that the franchise agreement may be terminated and you will be unable to recover any amounts from the franchisor for your loss.
How we can help you
Slater and Gordon can help you by:
- Helping you to understanding your franchise agreement or lease
- Providing you with advice about your rights and obligations as a franchisee in a company
- Assisting you to negotiate a resolution regarding an existing franchising dispute
- Representing you in any legal proceedings relating to a franchising dispute
Learn more about our dispute resolution services, or if you have an enquiry about a franchising dispute, submit an enquiry online.
[1] Franchising Code of Conduct s 5.
[2] Ibid s 9.
[3] Ibid annexure 1, cl 4.
[4] Ibid annexure 1, cl 8.
[5] Ibid annexure 1, cl 14.
[6] Ibid annexure 1, cl 21.1.
[7] Ibid s 3(1).
[8] Competition and Consumer (Industry Codes—Horticulture) Regulations 2017.
[9] Franchising Code of Conduct s 3(2)(a).
[10] Ibid s 3(2)(b).
[11] Ibid s 11.
[12] Australian Competition and Consumer Commission, Franchising Agreements, <https://www.accc.gov.au/business/industry-codes/franchising-code-of-conduct/franchising-agreements/>.
[13] Australian Competition and Consumer Commission v South East Melbourne Cleaning Pty Ltd (In Liq) (Formerly Known as Coverall Cleaning Concepts South East Melbourne Pty Ltd) (No 2) [2015] FCA 257, [4].
[14] Ibid [19].
The contents of this blog post are considered accurate as at the date of publication. However the applicable laws may be subject to change, thereby affecting the accuracy of the article. The information contained in this blog post is of a general nature only and is not specific to anyone’s personal circumstances. Please seek legal advice before acting on any of the information contained in this post.
