5 things franchisors must know about the inquiry

Seventy-one. That’s how many recommendations were made in the recent Parliamentary inquiry report into franchising. And sitting at over 350 pages, the report can be difficult (and time consuming!) to digest. That’s why we’ve broken it down into our top 5 things franchisors need to know.

1. Public register of franchisors

The Committee recommended that a public register of franchisors be established, requiring franchisors to provide updated disclosure documents and template franchise agreements annually.

This would allow franchisees to search the register and check that the franchisor is compliant, although the register would not be an endorsement of the franchisor.

Whilst a public register is a step in the right direction towards transparency, confidentiality issues will need to be taken into account in considering this recommendation. Discussed further below, in our view, mandatory advice would be more valuable in terms of ensuring franchisors are complying with the Franchising Code.

2. Supplier rebates

Supplier rebates are exceptionally common in franchise systems, and a by-product of the group buying power that franchise systems enjoy.

Currently, whether rebates are received, but not the amount, must be disclosed by franchisors to franchisees.

The report recommended (in great detail) that:

  • franchisors be required to disclose rebates as a percentage of the full purchase price on each transaction;
  • franchisors be required to detail what proportion of the supplier rebate will be retained by the franchisor and what proportion will be directed towards franchisees; and
  • an investigation take place into conflicts of interest associated with supplier rebates and third line forcing, for example, whether tender processes are influenced by the rebates received by franchisors.

Whilst supplier rebates may serve as an additional income stream for franchisors, they should not be a major contributor to the profitability of the franchise system. In our view, this recommendation is a fair and reasonable to approach to ensuring rebates are not being exploited to benefit franchisors at the expense of franchisees.

3. Penalties for unfair contract terms

A prohibition against unfair contract terms for small business was introduced in 2016 and directly affected franchise agreements.

Many franchisors reviewed their franchise agreements to bring them up to date with these laws, however the consequences of not complying are minimal. Currently, terms that are proven to be unfair are simply declared void. The argument from many experts during the inquiry was that this does little in deterring franchisors from including unfair contract terms in their standard form franchise agreements.

As such, the Committee recommended that civil pecuniary penalties and infringement notices apply where a franchise agreement contains an unfair contract term.

While this may be concerning to some franchisors, in practice, there is ample opportunity for franchisors to review their franchise agreement to ensure it is clear of unfair contract terms. This includes not only by review by the franchisor’s lawyer but also during negotiations with prospective franchisees.

4. Prohibition on passing on legal costs

It is commonplace for franchisors to pass on their costs for preparing franchise documentation to their franchisees. This makes sense, as legal costs can easily multiply, especially in larger franchise systems.

The Committee, however, recommended that franchisors be prohibited from passing on these legal costs. It also recommended introducing a civil penalty for any franchisor found to be deliberately attempting to increase franchise fees to circumvent this prohibition.

While certainly increasing a franchise fee by the specific legal costs would be an obvious avoidance tactic, we query how any laws could limit a franchisor’s genuine financial modelling. Any good model will take into account the costs of running a business, which will include legal costs. It will be interesting to see if this recommendation is adopted and how it is managed in practice.

5. Professional advice was missed

The general consensus among franchisees, franchisors and advisors alike was that mandating legal and financial advice for franchisees would solve many of the issues currently experienced by the sector.

Unfortunately, the report left this recommendation out, so that obtaining legal and financial advice still remains optional. The rationale behind this appeared to be that legal advice would be limited in scope, as franchisors are often reluctant to amend their franchise agreement.

The Committee stated at para 18.40 of the report:

“…legal advice may be compromised by the existence of broad discretionary powers in the franchise agreement which in turn limit the advising lawyer’s ability to advise other than in general terms.”

This view is somewhat misplaced. A good franchise lawyer or accountant will not direct their advice towards changing the franchise agreement alone. What is essential, however, is ensuring that franchisees have a clear understanding of what they are getting themselves in to. From a risk point of view, franchisees who have obtained their own independent advice are less likely to place complete reliance on the franchisor’s guidance, meaning there is less chance of misrepresentation claims down the track.

As a best practice tip, franchisors can implement a requirement that franchisees must obtain independent legal, accounting and business advice prior to signing the franchise agreement as part of their policy.

  • A franchising taskforce was established by the Federal Government recently to consider the recommendations. Any changes to the Franchising Code are unlikely to take effect until 2020 – watch this space!