5 ways to avoid a franchise agreement fail

What could possibly go wrong? How to ensure you don’t set yourself up for trouble when setting up or amending your franchise agreement.

As a franchisor, when drafting or amending your franchise agreement, you must first and foremost ensure that it complies with the requirements of the Franchising Code of Conduct, Australian Consumer Law (ACL) and other relevant legislation.  

Check these five ways to stay compliant and avoid a franchise agreement fail

1. Comply with the unfair contracts legislation

When drafting franchise agreements, franchisors and their advisers must ensure that the end document does not contain unfair contract terms under the unfair contracts regime (UCL) set out in the ACL.  The UCL has been in force since November 2016 in order to offer broader protection to small businesses.

In order for the UCL regime to apply, the contractual relationship must be:

  1. for the supply of goods and/or services (or it could also be a sale or grant of an interest in land); and 
  2. at least one small business must be involved; and
  3. for an upfront price of up to $300,000 or $1 million in the case of contracts with a term exceeding 12 months.

Many franchise agreements would fall within the UCL regime based on the above criteria and therefore franchisors must be careful in drafting in order not to breach the UCL regime and get proper legal advice.

2. Comply with the Franchising Code of Conduct

All franchisors in Australia must comply with the Code which sets out what areas must be covered in the franchise agreement and what areas must not be included.

For example, the Code prohibits franchise agreements from containing a general release of the franchisor from liability towards the franchisee or waiver of any verbal or written representation made by the franchisor.  The Code also dictates how disputes are to be handled and what needs to occur for the franchisor to be able to terminate the franchise relationship.

The Code also has time frames when and which documentation must be provided to the franchisees, how long franchisees must keep it for before signing as well as ability for franchisees to “cool off”.  Franchisors must review the current version of the Code to ensure that their franchise documents and their practices do not breach it.

3. Termination of the franchise agreement

The Code specifies how a franchise agreement can be terminated and the process required, if any, and the franchise agreement cannot override this or any other provision of the Code.  So the requirements of the Code in relation to termination rules should be spelt out in the franchise agreement.

One of the circumstances in which a franchise agreement can be terminated by a franchisee, is within seven days of signing of the franchise agreement, known as a cooling off provision.  At that point, the franchisor will be required to repay the franchisee any funds paid less reasonable expenses incurred by the franchisor. Most franchise agreements stipulate the exact amount the franchisee would lose on exercising their right to cool off on account of “reasonable costs” of the franchisor.

Franchisors can terminate the franchise agreement for breach with provision of requisite notice, or immediately if one of the special circumstances provided for in the Code occurs, which include when a franchisee:

  1. no longer holds a licence that the franchisee must hold to carry on the franchised business; or
  2. becomes bankrupt, insolvent under administration or a Chapter 5 body corporate; or
  3. in the case of a franchisee that is a company—become deregistered by the Australian Securities and Investments Commission; or
  4. is convicted of a serious offence; or
  5. voluntarily abandons the franchised business or the franchise relationship; or
  6. operates the franchised business in a way that endangers public health or safety; or
  7. acts fraudulently in connection with the operation of the franchised business.

In all other circumstances, the franchisor must:

  1. give to the franchisee reasonable notice, in writing, stating that the franchisor proposes to terminate the franchise agreement and outline the breach(es); 
  2. tell the franchisee how a breach can be remedied; and 
  3. allow the franchisee reasonable time to rectify the breach, usually 7 to 30 days.

Lastly, if the franchisor and the franchisee agree, then a franchise agreement can be terminated at any time by agreement.  It should be remembered that the franchise agreement cannot contain termination clauses which are contradicting to the above and the requirements of the Code.

4. Keep disclosure documents up to date

When the franchise documentation is provided to any franchisee, an up-to-date and compliant Disclosure Document must also be provided.  Such disclosure document must contain all the prescribed information and be updated annually, including the financials of the franchisor for the last two financial years (or audit report) and the financials of the marketing fund (plus an audit report unless 75 per cent of the franchisees vote against it).

The disclosure document must also contain proper costings of all fees and payments likely to be incurred by the franchisees, a list of current and past franchisees for the last 3 years and other information required by the Code.

It is advisable that even if the franchisors update their disclosure document internally on an annual basis, that they run the amended version past a franchise lawyer to ensure it is fully compliant.

5. Observe other laws

A good franchise agreement must be drafted in a way which protects the franchisor’s intellectual property and all their assets, covers all the obligations of the franchisee clearly and contains adequate disclaimers and permitted limitation of liability clauses.  Franchisors should also ensure that all other laws, outside the franchising arena, are also complied with such as privacy laws, competition laws, employment laws and other legislation relevant to businesses in Australia.