Doing business in Australia - Franchising issues

1. The commercial impact of franchising

Franchising is a well-established and credible business method in Australia, with franchise systems operating in most industry sectors. Indeed, there are more franchise systems in Australia per head of population than in the United States.

According to the peak industry body, the Franchise Council of Australia, there are 1,344 franchise systems in Australia, with an estimated 98,000 units turning over $184 billion, and employing more than 598,000 people.

Surveys of the sector confirm an increased maturity in the sector, with the following detail compiled from the Franchising Australia Surveys from 2012, 2014 and 2016:

• 60% of franchisors have been franchising for more than 10 years;
• franchisees remained in their businesses for an average of 7 years;
• 26% of franchisors were in retail non-food, 19% in accommodation and food services, 15% in business services (including travel agencies, office services, domestic and commercial cleaning, gardening services and lawn mowing), and 10% in personal and other services (including pet grooming, automotive repairs and IT services);
• 92% of the franchise systems reported they were Australian-based operations. This confirms that the majority of franchisors were home-grown Australian systems that have been franchising on average for 9 years;
• the average system had only 20 franchised units, with 46% of survey respondents having fewer than 20 units. Providing more insight into the average, the median for franchise systems with under 50 units was 15, whereas the median for those with over 50 units was 117;
• 27% of units were in New South Wales, 25% in Victoria, 23% in Queensland, 11% in Western Australia, 8% in South Australia, 2% in Tasmania, 2% in Australian Capital Territory and 1% in the Northern Territory; and
• 28% of franchise systems had expanded internationally.

Disputation in the sector remains very low, with only an estimated 1.8% of franchisees involved in a dispute that involved an external advisor, and 75% of franchisors reporting no disputation in their system. International expansion continues to increase, with 32% of Australian franchise systems currently franchising internationally. New Zealand remains the most common destination, followed by the UK, the US and Asia.

The Australian market is relatively mature and highly competitive. Although many foreign systems have successfully entered the market, there have also been a substantial number of failures. The biggest challenge in a mature competitive market is achieving critical mass, which in turn can be dependent upon the level of commitment of the brand to the market and the quality and resources of any chosen local partner. For retail franchise systems, access to prime sites can also be challenging, although much retail is conducted at major shopping malls that are keen to provide opportunities for new concepts.

More broadly, foreign franchise systems entering the Australian market typically find the market to be quite a high-cost market. Labour rates are high by international standards, with high minimum wages and penalty rates for out-of-hours work - features that often surprise. Real estate can be difficult to secure, with property rentals and energy costs high by international standards, particularly in major shopping centres. Foreign franchise systems seeking to enter the market should carefully review their cost structures as part of their market due diligence.

2. The regulation of franchising

Historically Australia has experienced almost all forms of franchise regulation, from corporate law regulation to de-regulation and voluntary codes of conduct.

On 1 July 1998, specific franchising legislation was enacted. The law, called rather misleadingly the Franchising Code of Conduct (Code), is black letter law and has been enacted under the Competition and Consumer Act 2010 (Cth) (CCA). The CCA makes compliance mandatory for all companies caught by the Code, and exposes franchisors and franchisees to the remedies available under the CCA. The CCA is administered by the Australian Competition and Consumer Commission (ACCC), which is one of Australia’s most active and effective regulatory bodies.

The Code has been amended on many occasions, with significant amendments taking effect as recently as 15 April , 2022. The current version of the Code is the Competition and Consumer (Industry Codes – Franchising) Regulation 2014.

The purpose of the Code is to regulate the franchise industry and otherwise assist franchisees to make an informed decision prior to entering into a franchise agreement. It is also intended to provide a framework for dispute resolution. The Code applies to all businesses that are bound by the CCA. With some limited exceptions, the Code applies to franchise agreements that are entered into, renewed, extended or transferred on or after 1 January, 2015, and to conduct occurring on or after 1 January 2015. Previous versions of the Code apply to franchise agreements entered into before 1 January, 2015. Amendments made to the Code, such as those that took effect on 15 April 2022, typically apply to franchise agreements entered into on or after the effective date.

A breach of the Code is a breach of the CCA, and will entitle a party which has suffered loss or damage to compensation, and enable a court to grant an injunction, require specific performance, declare void in whole or part any agreement, vary any contract or arrangement or make such other orders as a court thinks appropriate. Substantial penalties of 600 penalty units (AU$133,200) apply for breaches of key provisions of the Code. A breach of the Code which comes to the attention of the ACCC is likely to prompt an investigation, and may result in the institution of proceedings by the ACCC or the issuance by the ACCC of Infringement Notices of $13,320 per breach, with additional cost and possible adverse publicity. On application by the ACCC, a court can award additional sanctions of up to $10 million, 3 times the benefit received or 10% of annual turnover for egregious breaches. Fines of up to $500,000 can apply to individuals knowingly concerned in a breach of the law.

The application of the Code is largely determined by the core definition of a “franchise agreement”, which is very broad, and includes an agreement that takes the form, in whole or in part, of a written agreement, an oral agreement or an implied agreement. It catches any form of franchise, master franchise, licence or distribution agreement “in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor”. The definition simply requires that under the agreement:

• “the operation of the business will be substantially or materially associated with a trade mark, advertising or commercial symbol owned, used or licensed by the franchisor or an associate of the franchisor; or specified by the franchisor or an associate of the franchisor”; and
• “before starting the business or continuing the business the franchisee must pay or agree to pay to the franchisor or an associate of the franchisor an amount, including for example an initial capital investment fee, a payment for goods and services or a fee based on a percentage of gross or net turnover whether or not called a royalty or franchise service fee, or a training fee or training school fee.”

There are no exemptions to the application of the Code. Clause 5(3) of an earlier version of the previous Code provided the following exemption, known generally as the single foreign franchise exemption, as follows:

“This code does not apply to a franchise agreement if the franchisor is resident, domiciled or incorporated outside Australia and grants only 1 franchise or master franchise to be operated in Australia.”

This exemption was deleted from the previous Code with effect from 1 March 2008, and does not exist in the new Code. The removal of the exemption means that all franchise agreements executed between 1 October 1998 and 1 March 2008, including those previously exempt from the application of the Code, will be caught by the Code. The amendments therefore have a retrospective effect for foreign franchise systems that are parties to a franchise agreement entered into after 1 October 1998, but were previously exempt due to the single foreign franchise exemption. Most master franchise agreements entered into between foreign franchisors and a master franchisee which has the right to grant sub-franchises/unit franchises in Australia will be caught by the Code. This has implications for the form of the master franchise agreement and also means that foreign franchisors will need to comply with the disclosure requirements under the Code. (See comments in paragraph 3 below relating to “Disclosure”).

Franchisors are not required to register with any statutory authority prior to franchising, although following the April 2022 changes to the Code, franchisors must now provide information about the franchise system to be added to the Franchise Disclosure Register. This is an electronic register of information about franchise systems, which will be available for public inspection. The information input to the Franchise Disclosure Register will be made available from November 2022.

There is no State regulation of franchising in Australia other than legislation in South Australia that relates to the resolution of disputes in franchise agreements connected to South Australia. Franchisors are also able to conduct meetings and generally undertake preliminary marketing and prospecting in Australia, but may not enter into a binding agreement or take any non-refundable amount from a prospective franchisee or master franchisee without complying with the Code.

From 1 January 2015 franchisors must also provide an Information Statement in the prescribed form to a prospective franchisee within 7 days of the prospect formally expressing an interest in a franchise. The Information Statement is essentially a brochure on the advantages and disadvantages of franchising.

From 1 July 2021 franchisors have to provide a Key Facts Sheet with the disclosure document. The Key Fact Sheet is intended to be a shorter form summary of the key provisions of the disclosure document, and must be in the prescribed form. The Key Facts Sheet must also be updated annually in the same timeframe as is required for the disclosure document.

3. Disclosure

Franchisors are required to produce a disclosure document that strictly complies in form and content with the terms of Annexure 1 (full form) of the Code.

The disclosure document is required to be “in the form and the order and under the numbering” and “under the titles” set out in the annexures to the Code. Although some of the information contained in existing disclosure materials will assist in the preparation of the Australian document, foreign systems will need to instruct local counsel to undertake a comprehensive re-draft to meet the format requirements of the Code.

Where franchisors have foreign template franchise agreements, modifications to the templates will need to be made concerning releases of liability, freedom of association of franchisees, cooling off, assignment and termination. A general review of documentation for CCA compliance is recommended, as the terms and language of a franchise agreement will be relevant in assessing conduct such as unconscionable conduct. Plain English drafting is highly desirable.

Under the Code, a franchisor must give a disclosure document to a prospective franchisee or a franchisee proposing to renew or extend a franchise. For a prospective franchisee, this must be done at least 14 days before the prospective franchisee enters into a franchise agreement or an agreement to enter into a franchise agreement or pays non-refundable money to the franchisor or an associate of the franchisor in connection with the proposed franchise agreement. At the same time, the franchisor must also provide a copy of the franchise agreement “in the form in which it is to be executed”, which means that the document has to contain all commercial terms and be ready for signature. Failure to comply with this requirement can invalidate disclosure, and is a trap for foreign franchisors who may be used to providing more of a template franchise agreement with the disclosure material.

A foreign franchisor entering into a master franchise agreement with a master franchisee that has the right to grant unit franchises/sub-franchises in Australia will also need to give a disclosure document relating to the terms of the master franchise agreement to the master franchisee. As from 1 January 2015, a franchisor is required to give a disclosure document to a master franchisee, but the franchisor is not required to give a disclosure document to a sub-franchisee of the master franchisee. These disclosure requirements can create liability for foreign franchisors and so it is important that legal advice from an experienced franchise attorney is obtained regarding the form of these documents before entering the Australian market.

Franchisors are required to update their disclosure document annually within 4 months of the end of their financial year. They are also required to provide a copy of their current disclosure document to an existing franchisee within 14 days of receiving a written request. However there are some exemptions from updating for franchisors that have granted no more than one franchise agreement in the year, and do not intend to grant a franchise in the following year.

The disclosure requirements are complex and highly prescriptive. The disclosure document and Key Facts Sheet must be in the prescribed form and layout. Although a franchisor’s current foreign disclosure document will be useful as to content, it cannot be used to demonstrate compliance and indeed significant additional information is typically required in Australia.

4. Other Code Requirements

Advice. Under the Code, the franchisor must not enter into, renew or extend a franchise agreement unless the franchisor has received from the franchisee or prospective franchisee a written statement that the franchisee or prospective franchisee has received, read and had a reasonable opportunity to understand the disclosure document and the Code. Before a franchise agreement is made, the franchisor must have received from the prospective franchisee signed statements that the prospective franchisee has been given advice about the proposed franchise business, from at least an independent legal adviser, business adviser or accountant or has been told that such advice should be sought but has decided not to seek it.

Cooling Off. A franchisee may terminate an agreement (being either a franchise agreement or an agreement to enter into a franchise agreement) within 14 days after the earlier of entering into the agreement or paying any money under the agreement. There are additional requirements if a lease of premises is involved. If the franchisee terminates the franchise agreement pursuant to the cooling off right, the franchisor must, within 14 days, repay all money paid by the franchisee to the franchisor under the agreement, less reasonable expenses provided those expenses have been disclosed in the disclosure document given to the franchisee.

Marketing Funds. If, as part of the franchise scheme, the franchise agreement provides that a franchisee must pay money to a marketing or other cooperative fund, the franchisor must prepare an annual financial statement of the fund's receipts and expenses for the last financial year, including the percentage spent on production, advertising, administration and other stated expenses, It must also have the statement audited by a registered company auditor within 4 months after the end of the financial year to which it relates. The franchisor must give the franchisee a copy of the statement within 30 days of preparing the statement, and a copy of the audit report (if applicable) within 30 days after preparing the report. The requirement for the franchise statement to be audited does not apply for a financial year if 75% of the franchisees in Australia that contribute to the fund agree and such agreement is made within the period prescribed by the Code. Contributions to the marketing or cooperative fund must be kept in a separate bank account, and funds may only be spent in the manner prescribed by the Code.

Notification of End of Term Arrangements. Franchisors have additional disclosure obligations to clarify for franchisees what, if any, arrangements exist in relation to ending the franchise term. Franchisors must also give at least 6 months’ notice of their decision to renew or not to renew a franchise agreement or to enter into a new franchise agreement. Where a franchise agreement is for less than 6 months, the notice period is at least 1 month.

Continuous Disclosure of Materially Relevant Facts. The disclosure document must be updated annually within 4 months of the end of the financial year. However, a franchisor is required to disclose to a franchisee if it becomes aware of certain materially relevant facts, including any change in majority ownership or control of the franchisor, any proceedings by a public agency such as the ACCC, or a judgment or arbitration award in criminal or civil proceedings in Australia against the franchisor alleging breach of a franchise agreement, contravention of trade practices law or the CCA, unconscionable conduct, misconduct or an offence of dishonesty, a judgment against the franchisor under certain workplace relations and industrial relations laws, or civil proceedings in Australia against the franchisor or an associate of the franchisor by 10% or 10 of the franchisees in Australia of the franchisor (whichever is the lower). Disclosure must be made within a reasonable time, but not later than 14 days after the franchisor becomes aware of the relevant facts.

Transfer and termination. The Code provides that a franchisor cannot unreasonably withhold consent to a franchisee’s request to assign a franchise agreement; this somewhat curtails a franchisor’s ability to terminate a franchise agreement. Immediate termination is only available in very limited circumstances, with most cases requiring a franchisee to be given written notice of default and an opportunity lasting not more than 30 days to cure the default. Immediate termination of agreements entered into from 1 July 2021 requires 7 days’ notice to be given and reasons provided, and can be inhibited by a franchisee activating a dispute resolution process. The Code also requires disclosure of whether the franchisor will amend the franchise agreement prior to, or on transfer of, a franchise agreement.

Dispute resolution. The Code contains a mediation process which, if activated by a party, is mandatory. Mediation is a process involving the resolution of disputes by consensus. The mediation process has been extremely successful in resolving disputes, with a success rate in excess of 80%. The Code encourages franchisors and franchisees to consider arbitration. If the parties do choose mediation or arbitration, the mediation or arbitration must be conducted in Australia. Where there are similar disputes, franchisees or the franchisor may require that they are resolved by a single dispute resolution practitioner and process.

5. The Competition and Consumer Act

The CCA regulates business conduct in Australia, promoting fair and effective competition and consumer protection. The CCA is administered by the ACCC, which takes an aggressive and very public role in enforcement. This role is in addition to the supervision of compliance with the Franchising Code of Conduct. This means the ACCC may take action at any time against a franchisor for non-compliance with the Code. The ACCC will also be the first point of contact for reporting serious non-compliance by franchisors.

The CCA, and the Australian Consumer Law (ACL) which is incorporated in Schedule 2 of the CCA, makes certain conduct, including misleading or deceptive representations, unconscionable conduct, third line forcing and resale price maintenance, illegal. Disclosing illegal conduct in the disclosure document will not prevent that conduct being a breach of the CCA. The important sections of the CCA and the ACL that must be borne in mind are principally:

• Section 18 of the ACL, which prohibits misleading or deceptive conduct. Section 4 of the CCA augments section 18 by providing that a person making any statement as to a future event (such as a projection as to turnover) must be able to prove they had reasonable grounds for making it;
• Section 22 of the ACL, which provides that a corporation must not, in trade or commerce, engage in conduct that is in all the circumstances “unconscionable”; and
• Chapters 2, 3 and 4 of the CCA, which contain a range of prohibitions against restrictive trade practices, such as price fixing, misuse of market power, resale price maintenance and covenants affecting competition.

Contravention of the provisions of the CCA can result in severe penalties. In the case of breaches of some provisions in Chapters 2, 3 and 4, including the price fixing provisions, these can include fines up to $500,000 for individuals. In the case of corporations, penalties can be as much as the greatest of:

• $10 million; or
• where the value of the benefit attributable to the breach can be ascertained, three times the value of that benefit; or
• where the value of the benefit attributable to the breach cannot be ascertained, 10 per cent of the annual turnover.

However it is possible for certain conduct to be authorised, or enforcement action avoided, by using the ACCC’s authorisation or notification processes. These processes can be helpful in tied supply situations or where there is a technical breach of the CCA, but the conduct has little commercial impact or there is a public benefit associated with the conduct.

The ACCC has a range of enforcement options open to it. When choosing which option to take, the ACCC will assess how flagrant the breach is, the public detriment, the educative effect and whether it will be creating a new law or a new market issue. When assessing appropriate enforcement action for breach of the Code, the ACCC may also investigate, among other things, whether franchisors have effective compliance systems in place so as to prevent further problems in relation to compliance with the Code and the CCA.

6. Prohibition of unfair contract terms

On 12 November 2015, the Federal Parliament enacted legislation that prohibited “unfair” terms in standard form small business contracts - The Treasury Legislation Amendment (Unfair Contract Terms) Act 2015. The legislation took effect from 12 November 2016. Further legislation has been proposed in 2021, but not yet been passed, to expand the application of the provisions, alter certain key definitions, make it an offence to include an unfair contract term in a standard form small business contract, and increase the applicable penalties.

As a “small business” is defined as a business with fewer than 20 employees, and a typical franchise agreement exhibits many of the characteristics of a “standard form contract”, the legislation is likely to apply to many franchise agreements.

There are some exclusions for agreements where the up-front fee is more than $300,000 (or $1,000,000 for a contract with a term of more than a year), and certain special types of contracts. Further, where an agreement such as a franchise agreement is negotiated and there are genuine opportunities for amendment, it may not be considered a “standard form” contract presented on a “take it or leave it” basis.

A detailed analysis of the legislation is beyond the scope of this document, and further amendments are under consideration. It suffices to say that if a franchise agreement is found to be a standard form small business contract, many of the typical provisions found in franchise agreements will need to be carefully scrutinised to determine if they are “unfair” terms. The legislation gives numerous examples of provisions that could potentially be “unfair”, including a term that:

• permits one party (but not another party) to avoid or limit performance of the contract;
• permits one party (but not another party) to terminate the contract;
• permits one party (but not another party) to vary the terms of the contract;
• limits one party's liability or right to sue; or
• permits one party to assign the contract to the detriment of another party without that other party's consent;

The legislation provides that a provision in a small business contract will be “unfair” if:

• it would cause a significant imbalance in the parties’ rights and obligations arising under the contract; and
• it is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term; and
• it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.

For a court to declare that a term is unfair, all three of the above elements must be proven. The burden of proof is on the party advantaged by the term to prove it is reasonably necessary to protect their legitimate interests. In determining whether a term is unfair, the court may take into account such matters as it thinks relevant, but must take into account the extent to which the term is transparent, and the context of the provision in the contract as a whole.

If the court declares a provision of a contract “unfair”, that provision will be void. The contract will, however, continue to bind the parties if the contract can operate without the unfair term. Proposed legislative amendments to introduce penalties for the inclusion of an unfair contract term into a standard form small business contract are likely to be a game-changer for businesses, as it will no longer be possible to take a “wait and see” approach to whether a court determines a clause to be an unfair term.

7. Extended workplace liability for franchisors

Although many jurisdictions have contemplated extending the responsibility of franchisors to the workplace law obligations of their franchisees, Australia has been the first to actually legislate such an obligation. Section 558B was introduced to the Fair Work Act 2009 by the Fair Work Amendment (Protecting Vulnerable Workers) Act 2017 to make a “responsible franchisor entity” liable for the workplace law breaches of a franchisee in certain circumstances.

The legislation provides that a “responsible franchisor entity” is liable for certain contraventions of the Fair Work Act by an employer that is a “franchisee entity” where the franchisor, or an officer of the franchisor, “knew or could reasonably be expected to have known that the contravention by the franchisee entity would occur, or a contravention of the same or similar character was likely to occur”. Section 558(3) and (4) set out a defence for a person that takes reasonable steps to prevent the contravention. This would include a responsible franchisor or an individual who aids and abets a breach.

The legislation links back to the much broader Corporations Act definition of a franchise, rather than that contained in the Franchising Code of Conduct. Section 9 of the Corporations Act 2001 defines a “franchise” as “an arrangement under which a person earns profits or income by exploiting a right, conferred by the owner of a right, to use a trade mark or design or other intellectual property or the goodwill attached to it in connection with the supply of goods or services. An arrangement is not a franchise if the person engages the owner of the right, or an associate of the owner, to exploit the right on the person’s behalf.” Many licence and distribution arrangements are therefore likely to come within the ambit of the legislation.

Franchise systems looking to do business in Australia will need to obtain specific advice on the extent of their potential liability, and the steps they will need to take to ensure they can either escape the ambit of the legislation or satisfy the test of taking “reasonable steps”.

[Disclaimer: The Competition and Consumer Act, the Franchising Code of Conduct and the Fair Work Act are complex laws. This article summarises the law and is not intended to be comprehensive, or to constitute legal advice.]