How to handle renewal issues under the new Code
The renewal or extension of a franchise agreement is an important right and greatly impacts on the franchisor and franchisee in different ways.
For a franchisee, renewal or extension of their existing agreement will enable the franchisee to continue operating the business, maintain their goodwill and provide them an opportunity to sell their business and/or assign their rights, hopefully for a reasonable return.
For a franchisor, renewal and/or extension of its franchise agreements ensures their ongoing revenue stream via royalties and margin on the supply of products and maintains the value of their franchise system as a whole.
Two things are obvious: a franchisee who is doing well will want to renew and a franchisor will want their productive franchisees to continue on in the system.
Transitional provisions under the Code
The obligations under the 1998 Code continue beyond 1 January 2015, where the agreement was entered into before 1 January 2015, unless that agreement was varied, extended or transferred on or after that date.
Later extension of the term of an old agreement, on or after 1 January 2015, brings the agreement under the new Code in its entirety, without any carve outs. Even a minor variation to a pre 1 January 2015 franchise agreement will be sufficient to bring that agreement under the new Code entirely.
New Code definitions
The definitions under the new Code (Clause 4) are important in understanding the renewal rights and obligations.
The terms 'extension' and 'renewal' are now clearly defined.
Extend means a material change to any or all of the following:
- the terms and conditions of the agreement;
- the rights of the franchisee;
- liabilities that would be imposed on the franchisee.
Renewal occurs when the franchisee chooses to renew the agreement; however the new contract does not have to be identical.
The new franchise agreement can contain new provisions and conditions such as new sales targets or licensing requirements as a condition to renewal.
A change in control of the franchise business with the consent of the franchisor is deemed a transfer, not a new franchise agreement.
Can the franchisor refuse to renew?
Franchisors need to bear in mind the obligations under Clause 6 at all times to act in good faith. These obligations now prevent a franchisor from acting in their legitimate commercial interests and not granting a renewal.
So can a franchisor refuse to renew or extend a franchise agreement where the franchisee has chosen to go ahead?
The Code is silent on this and so the decision is subject to any conditions or limitations set out in the agreement; for example the franchisor may be entitled to refuse to grant a further term if the franchisee is in default at the time.
Franchisors obligations of disclosure
Where there is a renewal or an extension of a franchise agreement the Code requires the franchisor to give the franchisee the latest version of its disclosure document updated within four months of the end of the financial year, at least 14 days before renewal or extension.
A franchisor who fails to provide an existing franchisee with a copy of the Code and disclosure documents at least 14 days before renewal or extension or the payment of a non-refundable fee, is subject to a civil penalty of 700 penalty units (that is a fine of $54,000).
Franchisors may also consider providing franchisees with legal, independent business advice and accountant’s advice certificates at the time of renewal and extension although that is not a mandatory requirement under the Code.
End of term issues
A franchisor must give a franchisee notice in writing whether it intends to extend the franchise agreement or enter into a new agreement not less than six months before the end of the franchise term. If the franchisor intends to extend the agreement, it must also advise the franchisee that they can request an up-to-date disclosure document.
A failure to provide the notice not less than six months before the end of the term or not advise the franchisee they can request a disclosure document, may leave the franchisor liable to a civil penalty of 300 penalty units.
If the franchisor does not agree to extend the existing agreement, or enter into a new agreement and fails to offer the franchisee “genuine compensation” for its good will, when the agreement expires the franchisor will not be able to enforce any non-compete provisions against the franchisee.
Genuine compensation is not defined and will no doubt be a matter of some contention. It needs to be determined on reasonable and objective content.
Provisions in relation to non-solicitation and confidentiality remain enforceable by the franchisor.
This end of the term issue is an important one for franchisors to consider.
- Franchisors should maintain complete franchisee file records with and all communications whether emails or otherwise, and diarise critical dates for each franchisee, to ensure their compliance. These records will be essential to avoid possible civil penalties in case of audit or inspection of their records by the ACCC
- Make sure all documents are properly signed and dated by all relevant parties at the outset.
- Diarise the date not less than six months before the end of term to give the franchisors notice. (We suggest you diarise one month before that date.)
- Don’t forget the general ongoing disclosure obligations, if there is a significant change to the system that may affect franchisees.
- Monitor franchisee performance and consider the end of term obligations, whether to extend or renew the franchise agreement.
- Make sure your financials are up to date.
Franchisors and franchisees must now plan before the term ends whether to continue the agreement.
There are tricks and traps and civil penalties now apply for a failure to comply with the Code so seeking specialist advice is vital.
The Code requires both parties to act in good faith, and this extends to negotiations going into the agreement, conduct during the term, and negotiations around, renewal and exit arrangements.