fran C hise laW 101

Esther Gutnick | Senior Associate mst lawyers

About the Author

Esther Gutnick is a Senior Associate in the Corporate Advisory and Franchising Team of Melbourne-based law firm MST Lawyers and has been practicing in the franchising space for over 17 years.

Esther has authored numerous franchise articles and handles a wide variety of franchising and commercial matters, acting for both franchisees and franchisors, including local, national and international franchise systems. Her practice focusses on:

• Acquisition and disposal of franchise networks and independent businesses

• Establishment of franchise systems, including structuring advice and drafting key franchise documentation

• International and master franchising, assisting Australian franchise systems to expand offshore and overseas franchise systems to enter into the Australian market

• Advising both franchisors and franchisees on compliance matters, including compliance with the Franchising Code of Conduct and Australian Consumer Law

• Advising both franchisors and franchisees in relation to franchise dispute resolution

• Advising franchisees and franchisors in relation to sales and acquisitions of franchised businesses and reviewing franchise documentation

Asreaders may be aware, the franchise landscape in Australia has significantly evolved in the past 12 or so months, after several years of debate, inquiry and a government review of the sector culminating in a number of legislative changes made in an attempt to make franchising fairer for all participants.

Although some new documents, procedures and additional franchisee rights have been introduced, the fact remains that, like any other business venture, investing in a franchise is a serious commitment and involves considerable planning and paperwork.

If you have not previously purchased a business or a franchise business, you may feel as though you don’t know where to begin. Being presented with a volume of unfamiliar legal documents for the purchase of a franchise business can be somewhat intimidating. This chapter will focus on the process and key legal matters you should consider before investing in a franchise business and when reviewing the documentation.

Due Diligence

To ensure that you are fully informed and aware of all relevant risks, it is critical to undertake appropriate due diligence before entering into a franchise agreement. As part of proper due diligence, you should:

(a) Conduct basic internet searches of the franchisor and the franchise system, which can unearth useful information about the franchisor and its reputation in the industry.

(b) Search the Australian Government’s new Franchise Disclosure register, which is intended to assist prospective franchisees in the due diligence process. At the time of writing this chapter, the register is still being established and is expected to ‘go live’ on 15 November 2022. Once operational, anyone will be able to search the public register to view franchisor profiles and certain disclosure information. This may assist in comparing different franchise systems or different franchisors within the same industry. See: https://franchisedisclosure.gov.au/.

(c) Visit the Australian Competition & Consumer Commission (ACCC) website. The ACCC is the regulatory body that governs franchising and other industries. Its website contains news and useful information regarding the Australian franchising industry and in particular, it provides free educational resources and publications to potential franchisees including:

(i) the Franchisee Manual: https://www.accc.gov.au/publications/the-franchisee-manual;

(ii) Franchising: What You Need To Know: https://www.accc.gov.au/publications/franchising-what-you-need-to-know;

(iii) Quick Guide to a Franchise Disclosure Document: https://www.accc.gov.au/publications/quick-guide-to-a-franchisedisclosure-document;

(iv) Various information, interactive courses and videos (available in several languages) about the risks of Franchising: https://www.accc.gov.au/business/industry-codes/franchising-code-ofconduct/thinking-about-buying-a-franchise;

You can also sign up to the ACCC Franchising Information Network at: https://www.accc.gov.au/media/subscriptions/franchising-informationnetwork to receive email updates regarding news and events relevant to the small business and franchising sector.

(d) Visit other relevant websites, such as: www.business.gov.au, which provides information about franchising and running a business.

(e) read the Franchising Code of Conduct (the Code), which is the mandatory national code governing franchising in Australia and the conduct of franchising participants towards each other. A copy of the current Code can be found here: https://www.legislation.gov.au/Details/F2022C00463

(f) For franchises conducted from specific premises or within a specified territory, analyse the proposed location and/or territory. For example, does the franchisor have a site selection policy and did it conduct demographic and traffic flow analysis of the proposed site? Is the franchisor planning to expand its network within or around the territory and what rights will you have to purchase any adjacent, competing territories? Are there any other competing businesses in the area? What are the occupancy costs, such as rent and outgoings, of the premises and are there any refurbishment works required by the owner of the premises?

(g) read the franchisor’s key facts sheet and disclosure document. The disclosure document provides comprehensive, important information about the franchisor and the system, including details of the key people involved, any current legal proceedings, the estimated establishment and running costs of the franchise business, the contact details of existing and certain former franchisees and details of what will happen at the end of the franchise agreement. The key facts sheet, which was introduced by the 2021 Code changes, is a shorter summary of the information contained in the disclosure document and provides a handy snapshot of critical details relevant to the franchise system and business.

(h) Contact several existing and former franchisees of the franchise system and question them to glean first-hand information about the franchisor, how the system operates and the pros and cons of running the franchise business. Former and current franchisees’ contact details should be in the franchisor’s disclosure document. Your investigations should include queries regarding:

(i) how the actual set up and operating costs compare to estimates provided by the franchisor;

(ii) whether any estimates, projections or other financial information provided by the franchisor proved to be accurate;

(iii) how much training, support and assistance is given by the franchisor, especially to franchisees in states/territories other than where the franchisor’s head office is located;

(iv) whether the franchisor’s key staff are accessible, organised, helpful and amenable to both queries and suggestions;

(v) what is the relationship between franchisees within the franchise system; and

(vi) where franchisees have left the system, the reasons for their departures and how this was managed by the franchisor.

(i) request financial data or earnings information from the franchisor (and/or the seller if you are buying an existing franchise business). Be aware that franchisors are often reluctant to provide such information to avoid the risk that it may subsequently be found to be misleading or deceptive. If the franchisor does provide you with any earnings information, the same information must be attached to the disclosure document ultimately issued to you by the franchisor.

(j) If you plan to buy an existing franchise, request a copy of the business sale contract, the existing lease and disclosure statement in respect of the premises (if relevant). In some states of Australia, a vendor of a small business is required to provide a statement to the purchaser containing prescribed financial and operating information about the business. Even if the vendor is not legally obliged to provide a vendor’s statement, you should ask to see the financial records of the business for at least the last three years.

(k) request a copy of the franchisor’s operations manual to get a feel for the dayto-day operation, policies and procedures of running the franchise business. If the franchisor is reluctant to give you a copy, since the manual contains confidential information, you may request permission to inspect the manual under supervision at the franchisor’s head office.

(l) Attend franchising industry events and speak with various different franchisors, franchisees, consultants, advisers and other people involved in the sector.

(m) Obtain advice from an independent accountant and/or business adviser on the most appropriate business structure you should use to own and operate the franchise business. Your adviser will guide you as to the best structure for minimising costs, taxes and personal risk and for protecting personal assets, such as the family home. Common structures include: (i) sole proprietor; (ii) company; (iii) partnership; (iv) trust; (v) corporate trust.

You will need to make this decision prior to entering into the franchise agreement so that you and your advisers have sufficient time to set up the structure and prepare necessary documentation. Some franchisors have policies about which business structures they will allow franchisees to use. Therefore, before spending time and money establishing your structure, you should seek the franchisor’s approval of your proposed structure.

(n) Obtain advice from an independent legal advisor in respect of:

(i) the business and all franchise and sale documents that you will be required to sign;

(ii) any lease and disclosure statements provided by the landlord in relation to the premises from you will conduct the franchise business. You may have different rights and obligations depending on whether you, or the franchisor, is to be the tenant under the lease. If the latter, you will likely be required to enter into a separate sub-lease or occupancy licence agreement with the franchisor; and

(iii) your obligations as an employer under the Fair Work Act 2009 (Cth) and various other obligations as a business owner;

the Documents

The volume and complexity of documents that you are likely to receive can be daunting. Be prepared to receive the following:

(a) Preliminary Documents, including:

(i) Various application forms and questionnaires which the franchisor may use to assess you as a prospective franchisee candidate;

(ii) A “Confidentiality Agreement” or “Non-Disclosure Agreement” which you may be required to sign before you are given access to any of the franchisor’s confidential documents;

(iii) The Information Statement for Prospective Franchisees – this is a prescribed form document which the franchisor must give you within 7 days after you express your interest or make a formal application, and before giving you any of the other Franchise Documents listed below;

(b) Franchise Documents, including:

(i) The franchisor’s current key facts sheet;

(ii) The franchisor’s current disclosure document;

(iii) The franchise agreement in the form which you will be required to sign;

(iv) A copy of the current Code;

(v) If relevant, a copy of the premises lease (or a summary of the negotiated commercial terms) and any disclosure statement given by the landlord in respect of the premises; and

(vi) Any other agreements the franchisor requires you to sign, such as a hire purchase agreement, loan or security agreement;

(vii) Additional documents such as a site/territory history notice, any occupancy agreement, legal advice certificates, acknowledgement forms, representations statements and authority forms.

To verify that the key facts sheet and disclosure statement are current, check the preparation date (which must appear on each document) and ensure that each has been updated within 4 months after the end of the last financial year as required by the Code.

The Code stipulates that you must be given a minimum waiting period of 14 days to read, understand and seek advice on the franchisor’s disclosure document, franchise agreement and the Code before entering into the franchise agreement or making any non-refundable payments. After reading the documents yourself, you should seek legal advice regarding the documents and raise any queries with your legal adviser and/or the franchisor.

Take comprehensive notes in each meeting or discussion you have with the franchisor and/or its representatives, both prior to and after entering into a franchise agreement. Any representations or promises made by the franchisor before you enter into the franchise agreement should be confirmed in writing and any special deals or arrangements agreed between you and the franchisor should be reflected in special conditions in the franchise agreement. Your legal adviser can assist you with this.

You should not sign any documents without first having sought legal and financial advice. In fact, the Code requires that, before entering into a franchise agreement, a franchisor must obtain the franchisee’s signed statement confirming whether the franchisee either obtained legal, business and accounting advice or elected not to, despite being advised to do so.

the Financials

understanding the financial investment required to operate a franchise business is a key aspect of proper due diligence and budgeting. There are many one-off and recurring payments that you will likely incur before purchasing the franchise business, during the course of operating the franchise business and even upon exiting the franchise business.

Typical costs include:

(a) An up-front franchise fee for the right to operate the franchise business and use the franchisor’s branding, trade marks and systems. The franchisor may also request that you pay an earlier deposit as evidence of your commitment to purchase the franchise business;

(b) Equipment costs and, if the franchise business operates from fixed premises, either fitout costs (for new premises) or refurbishment costs (for existing premises);

(c) Initial stock costs;

(d) Lease costs, including upfront security deposits or bank guarantees required to be provided to the landlord and ongoing occupancy costs such as rent and outgoings (where the franchise business operates from fixed premises);

(e) Ongoing royalties, franchise fees or service fees. These payments are typically periodic and are either a fixed sum or calculated as a percentage of the revenue of the franchise business;

(f) Ongoing marketing or advertising contributions, whether a fixed dollar amount or a percentage of sales. These fees must be held by the franchisor in a separate bank account and are typically used to pay for promotional activities on behalf of the entire franchise network. The Code strictly regulates the use of marketing fund contributions and the financial statements of the fund that must be given to you. However, despite this, franchise agreements usually give a franchisor broad discretion as to the permitted expenditure of fund monies and expressly preclude any obligation for the franchisor to spend any fund monies on particular franchisees or their territories;

(g) Local area marketing costs. In addition to paying contributions to the franchisor’s marketing fund, the franchise agreement may also require you to spend a certain amount of money on your own marketing initiatives within your local territory and provide evidence of such spending to the franchisor;

(h) Software or technology fees. You may be required to make use of the franchisor’s designated software, hardware and/or point of sale systems and pay the associated costs. Such costs may also encompass website maintenance and information technology support. Technology fees may also be fixed or calculated as a percentage of your revenue;

(i) Training fees. These may comprise initial training programs provided by the franchisor prior to the start of the franchise business plus additional training required during the term of the franchise agreement, including refresher training or new product training. You will likely be required to bear any travel and accommodation costs associated with attending training and staff wage costs if your employees are also required to attend;

(j) renewal or further term fees. If you have an option to renew the franchise business for a further term after the initial term expires, you may be required to pay an additional fee for the continued right to operate the franchise business for the further term;

(k) Sale, transfer or assignment fees. If you wish to sell or transfer your franchise business to another person during the term of the franchise agreement, you will typically be obliged to pay to the franchisor either a fixed fee or a percentage of the sale price and potentially also the franchisor’s costs of approving the sale and the new franchisee. Some franchise agreements have a ‘sliding scale’ transfer fee, with a higher fee payable the earlier the franchise business is sold. It is prudent to bear the transfer fee in mind when determining the sale price of the franchise business;

(l) upgrade or renovations Costs: if the franchise business operates from fixed premises, the franchisor or the landlord may require the premises to be renovated or refurbished at your cost. You will need to budget for this from the outset;

(m) relocation costs: if the premises become unsuitable or the lease ends during the term of the franchise agreement, you may be obliged to relocate the business to new premises at your cost. This may include costs for any make-good works required at the old premises and the cost of any fitout, signage and branding required to be installed at the new premises;

(n) Legal costs. Franchisors often require franchisees to pay their legal and administrative costs incurred in preparing, negotiating and executing the franchise agreement. However, you will only be obliged to pay these costs if the fixed dollar amount is clearly specified in the franchise agreement. The franchisor’s ability to pass on other legal costs was restricted by the 2021 Code changes.

(o) Dispute resolution costs. If you and the franchisor end up in a dispute under the franchise agreement, you will be obliged to pay for your own legal advice, together with your share of the costs of any mediation or conciliation.

It is worth noting that, under the Code, the franchisor must not require you to undertake significant capital expenditure (for example refurbishment costs) during the term of your franchise agreement, unless the franchisor included such expenditure in the disclosure document provided to you and explicitly discussed such expenditure with you before the franchise agreement was entered into.

Please also bear in mind that you will incur a myriad of other operating costs of conducting the business, such as staff wage costs, inventory, consumables, accounting and banking expenses, licence or permit costs, cleaning and/or maintenance costs (whether for premises, vehicles or equipment), utilities, and any compliance costs relevant to your business. You should include all of these, together with the fees and payments listed above, in any budgets and forecasts prepared by you or your accountant.

A summary of payments owed to the franchisor and operating costs of the business is included at Item 14 of the disclosure document.

Will i be restricted in how i run the business?

Yes! remember that a franchise business is not your own independent venture and the success of a franchise system usually relies upon uniformity across the network. You will be bound to comply with all the obligations in the franchise agreement and conduct the business in accordance with the franchisor’s specified policies and directives. This can extend to every aspect of the business, from trading hours and recipes to how you greet your customers. You may be restricted in relation to which products and suppliers you can use, where you can conduct or even just market your business, the price at which you can sell goods or services, the frequency and type of reports you must produce, the insurances you must obtain and more. If this sounds too restrictive, then franchising may not be right for you!

Can i sell my Franchise business?

You will need to make written request to obtain the franchisor’s consent if you wish to sell or transfer the franchise business. Beware that simply changing your ownership structure may constitute a transfer of the business. A franchisor cannot unreasonably withhold its consent to a transfer or sale of the franchise business. However, a franchisor may require you to provide certain information to make its decision, and may reasonably withhold its consent to a sale if:

(a) the purchaser is unlikely to be able to meet the financial obligations under the franchise agreement;

(b) the purchaser does not meet a reasonable requirement of the franchise agreement; (c) the purchaser does not meet the franchisor’s selection criteria;

(d) the purchaser does not agree, in writing, to comply with the obligations under the franchise agreement;

(e) you have failed to pay an amount owing to the franchisor;

(f) you have failed to remedy a breach of the franchise agreement; or (g) the purchaser has not given the franchisor a statement that it has received, read and had a reasonable opportunity to understand the prescribed documents.

You should take note of the various costs that may be payable by you upon a sale, such as the transfer fee mentioned above, the franchisor’s costs incurred in reviewing the sale documents and approving the purchaser as a franchisee, and your own legal and accounting costs associated with the sale.

Even once you sell the business, you should be aware that, in certain circumstances the Code allows the purchaser to ‘cool-off’ and terminate the sale agreement for up to 14 days after the purchaser takes ownership of the business. If this occurs, you may be obliged to refund all monies paid to you by the purchaser and become the franchisee of the business again.

Can i bequeath the Franchise business to my Children?

Ordinarily, no. A franchise agreement is almost always for a finite period and will not be yours to keep forever. If you want to build a business and leave it as a legacy to be inherited by your children or other successors, then you should consider an independent business, not a franchise.

A franchise agreement is personal to you, and any attempt to hand it over to another person is considered a transfer of ownership, which requires the franchisor’s approval as discussed above. A franchise agreement usually contains rules about what is to happen to the business if you die, become ill or otherwise cannot continue to operate it. These contractual provisions will override anything to the contrary that you may include in your Will and the franchise business will not ordinarily form part of your Estate to be distributed.

Can i end the Franchise Agreement early?

If you are granted a new franchise (not a transfer, renewal or extension of an existing franchise agreement) the Code entitles you to a 14 day “cooling off period” after you enter into the franchise agreement. During this period, you may notify the franchisor that you wish to terminate the franchise agreement. If this occurs, the franchisor must repay all payments you have made under the franchise agreement (but the franchisor can deduct its reasonable expenses, if this amount is specified in the franchise agreement).

After the cooling-off period expires, you may only terminate the franchise agreement during the term if the agreement allows you to do so or the franchisor consents to the termination.

The 2021 Code changes introduced a statutory right for franchisees to propose termination at any time during the term of a franchise agreement, by giving the franchisor a written proposal setting out the reasons for the proposed termination. The franchisor does not have to agree, but must give a substantive written response to such proposal within 28 days, setting out its reasons for any refusal.

It is uncommon for a franchise agreement to otherwise give you contractual rights to terminate the franchise agreement. Accordingly, if you wish to exit the franchise early, you will either need to reach agreement with the franchisor, or seek legal advice to determine whether you have any rights to end the franchise agreement under general contract law principles, at Common Law, or by virtue of any other laws. This may be the case if, for example, the franchisor is in breach of an essential term of the franchise agreement or you entered into the franchise agreement as a result of the franchisor’s misleading or deceptive conduct or false representations. If the franchisor has engaged in misleading or deceptive practices, you may be entitled to seek a remedy, such as compensation, under the Australian Consumer Law and/or make a complaint to the ACCC.

Can the Franchisor end the Franchise Agreement early?

usually, a franchisor has greater powers to terminate a franchise agreement, both under the Code and under the terms of the franchise agreement.

The Code permits a franchisor to terminate a franchise agreement if:

(a) you breach the agreement and fail to remedy the breach within a reasonable time (up to 30 days) of receiving written notice of the breach and the franchisor’s required remedy;

(b) you have not breached the franchise agreement, but the franchise agreement allows for an early termination and the franchisor has given you reasonable notice of the proposed termination and reasons for it; and

(c) if the franchisor gives notice on particular grounds, including for example if you become bankrupt or insolvent, if you are convicted of a serious offence, or if you operate the franchise business in a way that endangers public health or safety.

Can i renew my Franchise Agreement?

A franchisor does not have to renew or extend your franchise agreement upon its expiry unless the franchise agreement gives you a specific contractual right to renew for a further term. Therefore, it is important that you negotiate a right to renew the franchise agreement for a further term before you sign the franchise agreement.

Even if you have an option to renew, the franchisor may refuse to renew the franchise agreement if the conditions for the renewal as set out in the franchise agreement have not been satisfied. For example, if you have been in breach of the franchise agreement during its term, if you cannot secure rights to occupy the premises for the further term, or even if you simply fail to provide the franchisor with notice of your intention to exercise your renewal option within any specified timeframes.

Can i operate another business after the Franchise Agreement ends?

Most franchise agreements bind you to a “restraint of trade” or “non-competition” period after the expiry or termination of the agreement. This means that you will be prevented from being involved in a competing business or business which supplies similar products or services, within a specified area and for a specified time frame after your franchise ends.

Before becoming a franchisee, you must consider how you intend to earn a living after you cease to operate the franchise business.

You should also seek legal advice as to whether the restraints in the franchise agreement are enforceable or otherwise seek to negotiate an exemption from, or a reduction of, any restraint with the franchisor.

What o ther Laws Will Apply?

Franchisees must be aware that, in addition to the Code and franchise-specific laws, a plethora of other laws may apply to them as small business owners. These are likely to include:

(a) laws regarding employment of staff and occupational health and safety regulations;

(b) if the franchisee is a company - the Corporations Act 2001;

(c) the Competition and Consumer Act 2010 (which contains the Australian Consumer Law);

(d) Privacy Laws (if you collect and store personal information of customers or other people); and

(e) any laws, regulations or licensing/permit requirements that relate specifically to the sector or industry in which your franchise business operates – for instance liquor licensing, food safety, financial and credit licensing, retail leasing laws, building and construction laws and various other industry Codes.

Franchisees should seek specific legal advice regarding such obligations to ensure the franchise business is operated in compliance with any applicable laws.

Conclusion

This chapter intends to provide a broad overview of the key elements of franchising and some preliminary assistance in navigating the legal documents and issues which you will face in becoming a franchisee. Buying a franchise is a serious undertaking and can certainly be a life-changing decision.

Although disclosure documents must all follow a standard form prescribed by law and franchise agreements contain common provisions such as those discussed above, franchise documents are notoriously lengthy and complex and it is all too easy to overlook a small, yet critical, detail.

It is therefore essential that you conduct comprehensive independent due diligence, read the franchise documents thoroughly, and obtain assistance from trusted, professional legal and financial advisers with expertise in franchising.