ChaPter 4: understandinG the LeGaL doCuments

ChaPter 4

understAndinG tHe LeGAL doCuments

robert toth | Consultant MARSh MAhER RIChMOND BENNISON LAwyERS

About the Author

Robert is an Accredited Commercial Law Specialist with over 30 years expertise in franchise law acting for local and international franchisors and franchisees. Robert regularly publishes articles on line and internationally on Franchise Licensing and Distribution and is a Member of the Franchise Council of Australia (FCA) the International Franchise Lawyers Association ( IFLA) and was recently named as a Leading Franchise Lawyer in Australia in Who’s Who Legal: Franchise 2021.

It is a whole new world in many ways for business due to a variety of factors that have come together to test small business over the past few years.

For prospective franchisees the process of searching and then selecting the franchise system is filled with a degree of excitement and trepidation

The franchise regime in Australia has for many years been highly regulated requiring Franchisor to provide information to a prospective franchisee to assist the franchisee to make an informed decision about whether to take up the franchise

The franchisee sees the franchisors glossy brochures and marketing spiel and it is easy to get caught up with the hype but the devil is in the detail as they say.

How does a franchisee make the right decision and really get to understand their rights and obligations before signing on the dotted line?

The best way to limit your risk and avoid making the wrong decision is to ensure you have a franchise specialist lawyer on board who can advise you and independent financial advice.

How do you find the right lawyer? contact the Franchise Council of Australia or one of the recognised franchise lawyers around town that contribute articles on line and in the franchise magazines.

Irrespective of how attractive and compelling the franchisors marketing and sales pitch may be, the primary decision should not be emotional it should be financial that is, will you be able to take a reasonable wage, pay expenses, interest on loans with a possible return on your investment.

Franchise lawyers who are members of the Franchise Council of Australia (FCA) are best placed to give you advice to minimise your risk as we know what’s going on in the franchise sector, the good the bad and the downright ugly!

the new Franchise Code regulations

On 1 June 2021, the Australian Government made amendments to the Franchising Code following the Government’s response to the Fairness in Franchising Inquiry in 2019.

Many of the changes affect agreements entered into, renewed, or extended on or after 1 July 2021 with some changes to dispute resolution for a dispute notified on or after 2 June 2021, even if the franchise agreement was entered into, extended or renewed before 2 June 2021.

Most of the regulations deal with further disclosure obligations for franchisors in the disclosure document and apply to disclosure documents given from 1 November 2021.

There is an updated information statement and new key facts sheet which is a summary of the key terms of the arrangement and highlights important information in the disclosure document.

The irony in all this is that franchisees now have more, not less documents to review and absorb before deciding whether to take up a franchise.

key documents:

Franchisors are required to provide a prospective franchisee on an enquiry an Information statement.

Franchisors will usually ask the franchisee to sign an NDA or confidentiality agreement before releasing further details or any financial or other confidential information about the system to the Franchisee.

Once the franchisee is approved a deposit or document fee is paid the franchisor will then issue the suite of franchise documents which should include

• A disclosure document with attachments including trade mark certificates, copy lease/licences and financial statements and copy of the Code; • The proposed franchise agreement in the form required to be signed by the franchisee;

• Any lease or offer to lease negotiated by the Franchisor or sub-lease or occupancy license;

• A receipt for the franchisee to acknowledge they received the suite of documents which starts the 14-day disclosure period; • The legal, accounting and financial advice certificates the franchisee should complete and return with the signed franchise agreement.

the “no Prior representation” statement

The franchisor may ask the franchisee to sign a no prior representations statement which is often overlooked by the franchisee or their advisors.

The statement requires that the franchisee to set out any representations, promises or statements made by the franchisor or their agent in the course of the negotiations. The franchisee cannot then later seek to rely on any representations or statements that are not set out in the statement.

It can be a vital document that can be relied on by a franchisor or franchisee if a dispute arises down the track.

So, the advice for franchisees here is, do not ignore this document and if the franchisor has made any promises and representations then make sure they are set out in writing in the franchise agreement as a special condition or get it in writing and set it out in this statement.

Seeking legal advice

Despite the Governments franchise code review they did not make it compulsory for franchisees to seek legal, accounting and financial advice.

Many franchisors however now insist their prospective franchisees seek such advice as this reduces risk to the franchisor.

Franchisees lawyers role

Seeking legal advice from a franchise law specialist will assist the process as they will focus on the important commercial issues and suggest areas of particular concern where there may be room for negotiation, rather than recommending wholesale changes to an agreement which are unlikely to be accepted by the franchisor.

One way to aggravate the relationship from the very beginning is a franchisee lawyer requesting a myriad of unnecessary changes or “rats and mice” changes.

Some basic rules for franchisees

Rule one: irrespective of whether you seek proper legal advice from a franchise law specialist (which we highly recommend) you should still read and become familiar with the documents. The franchise agreement is your contract and sets out your rights and obligations and those of your franchisor.

This will also assist you to identify any particular issues of concern which you can raise with your lawyer to advise on. Rule two: do not rely on advice from your suburban conveyancing lawyer, next-door neighbour or your mate at the pub! That’s not advice. Rule three: realise that entering into a franchise is one thing but exiting a franchise is not so easy.

Franchise agreements are typically 50 to 100 or more pages and can be difficult going without a glass of red wine in hand! There are many tricks and traps and more so with the recent changes to the Franchise Code which give franchisees additional rights. Your franchise lawyer will point out any unusual or unreasonable aspects in the agreement. Rule four: Franchisors will often say their agreements are not negotiable – that is not always the case and in fact we will often seek to negotiate reasonable concessions for a franchisee that can be included in the special conditions. There may be greater room to negotiate if the franchise is a new system and the franchisor is keen to roll out.

Things to reasonably negotiate might be a royalty free period while building the business, reduced establishment fees, reduced minimum performance criteria, further renewal terms, removal of restraint of trade provisions, franchisor finance towards the set-up costs. Any concessions offered or negotiated with the Franchisor should be set out in the agreement or some other written form, signed by both parties and dated prior to or on the date the franchise agreement is signed.

Disclosure document

Under the new Code franchisors are required to provide greater disclosure than previously.

Franchisors need to give the franchisee the disclosure document with key fact sheet to franchisees at least 14 days before they either enter into an agreement or make a nonrefundable payment.

The 14 day disclosure period will only start once the franchisor has made the full and proper disclosure required.

the key changes to the disclosure document are:

Lease information

The franchisor must provide full details of the lease and occupancy rights with a copy of any lease documents for example - offer to lease- agreement to lease- lease- sublease- occupancy license and lease disclosure statement issued by the landlord.

If the franchisor does not provide full and accurate information about the lease rights in the disclosure, the 14-day disclosure period does not start until they provide that information.

If the final lease details are different to the information in the disclosure document previously given, the 14 cooling off period only starts when that information is given, so the franchisor risks a franchisee being able to walk away.

This means the days of signing up a franchisee without a site or while in negotiations for a site are fraught with risk.

Franchisor’s must also disclose if they have any interest in the lease or freehold and also disclose any rent incentives offered.

rebates and financial benefits

The percentage of rebates the franchisor receives (financial benefit) from each supplier over the last financial year as a percentage of all purchases by franchisees in the group (this excludes supplies by the franchisor or associate of a franchisor) now has to be provided.

There is no need to disclose this information if the agreement allows the franchisee to buy from non-approved suppliers or the rebate is paid to a cooperative fund controlled by the franchisor.

Rebates do not include payment by a franchise to the franchisor, master franchisor or associate for a wholesale supply and a lease incentive is not a rebate, but franchisors still need to disclose the lease incentives.

Earnings information

Franchisors must if they give earnings information give it in the disclosure (not before or after signing the agreement) and include a statement that the information is correct to the best of their knowledge or state that the information may not be accurate.

A breach may attract a civil penalty of $66,000 and failing to provide the information means the 14-day disclosure period would commence only when the information is given and attached in the disclosure.

Capital Expenditure

Franchisors can only require a franchisee to undertake capital expenditure if a majority of franchisees agree where it affects the majority, or the express consent of the individual franchisee is given.

Term and restraint

Franchisors need to disclose if the franchisee has any right to goodwill at the end of term and if the agreement has a restraint or non-compete clause. The Code has been amended to provide that a franchisor can only rely on a “serious breach” of a restraint of trade clause. Note the serious breach is not defined and the breach would have to be before the agreement term ends. This sounds the death knock for restraint of trade provisions for Franchisors to a large extent so they will now be left with their right to protect their IP, know-how and confidential information.

Termination Rights

The 7 grounds for a Franchisor to terminate for “special circumstances” now require the Franchisor to give a franchisee 7-day prior notice of termination even for special circumstances and then allows the franchisee to raise a dispute.

The franchisor cannot terminate the franchisee if the franchisee raises a dispute and the parties must try and resolve the matter in that period or refer the matter to the ASBFEO for mediation or arbitration.

In the meantime, the Franchisor can require the franchisee not to operate the business in the 28 day period.

All franchise agreements will need to be amended to comply with these new provisions however these provisions do not apply to pre-1 July 2021 agreements until they are renewed or extended.

Cooling off rights and 14 day disclosure period

The 7-day cooling off rights for franchises are now extended to 14 days.

The 14 days disclosure period gets reactivated from when the franchisee receives the correct and final lease documentation.

The 14-day disclosure commences only if all documents and information are included in the disclosure at the time it is given, this includes earnings information and lease details, there fore if the lease information is given later or differs the franchisee has another 14 days disclosure period in which it may elect not to proceed.

Neither the franchisor nor franchisee can reduce the 14 day disclosure period. It is a minimum mandatory period.

Early termination rights for franchisees

Franchisee’s now have a right at any time during the term to write to the franchisor and seek an early termination (with reasons) of the agreement

The franchisor must then respond in writing in 28 days stating whether or not they agree.

If the franchisee does not agree (which is most likely) the franchisor must set out reasons in its response within that 28 day period.

We note there is no guidance as to what “acceptable reasons” are for a franchisor to refuse early termination. If there is a dispute the parties can then seek ADR via the ASBFEO.

Legal costs

It is illegal to charge franchisees for any undetermined and future legal service costs other than an upfront fixed fee set out in the agreement.

The upfront “fixed amount of dollars” (fixed fee) can only be for preparing, negotiating and executing the agreement

selling a franchise business

As franchisees now benefit from 14 day cooling off right even after settlement of the business has occurred when selling a franchise, it should be on the basis of the new franchisee entering into a new franchise agreement being entered into with the franchisor.

The sale contract should therefore include the following provisions:

a. the contract is subject to and conditional upon the Franchisors approval of the purchaser;

b. the purchaser acknowledging they have received at least 14 days before the franchisors consent, the full suite of franchise documents from the franchisor.

c. that settlement will only occur on the later of the date set out in the sale contract or the date after the 14 day cooling off period in favour of the purchaser ends.

Key facts sheet

A franchisor must now give a key fact sheet to a prospective franchisee with the disclosure document and update it every year as with the disclosure document.

marketing funds

The Code uses the word marketing, instead of advertising.to clarify the Code applies to more than just advertising It clarifies that marketing fund obligations apply to the fund administrator who could be the franchisor, master franchisor or a third party authorised to administer the fund for the franchisor or master franchisor.

Civil penalties apply for breaching the rules for payments to and from the marketing fund.

the operations manual

Most franchise agreements include provisions requiring franchisees to comply with the franchisor’s operations manual.

Franchisees should ask to see the operations manual before entering into the franchise agreement.

As it is a confidential document the franchisor may not agree to provide a copy of it until the franchisee signs the agreement. If that is the case, franchisees should ask to review the operations manual within the cooling off period.

the Franchise Agreement

This is your contract setting out your rights and obligations, generally weighted in favour of the franchisor with consequences for a failure to comply which may give rights to serve a breach notice and even termination.

It is often assumed by franchisees that the franchisor’s obligations are positive obligations, however most agreements will state the franchise “may “not that they “must” do certain things. Therefore, it is difficult to allege a franchisor has breached the agreement where they do not have a positive obligation.

Franchisees do have protections under the Franchise Code, the Australian Consumer Laws, Unfair contract provisions and can instigate the dispute resolution process and seek mediation or arbitration via the ASBFEO where a dispute cannot be resolved directly with the franchisor.

Fees payable to the Franchisor

Franchise Fees

The trend is that franchisors are tending to reduce the up-front franchise fee to make their franchise more attractive and affordable.

Franchisors will often charge a training fee but again many are rolling this fee into the up-front franchise fee

There are also a number of other fees that must be set out in the disclosure document that cover things such as technology and IT fees and also renewal and transfer fees.

Royalty

Most franchise agreements provide payment of a service fee or royalty typically paid monthly or weekly, either as a percentage of the franchisee’s gross sales or a specific dollar amount.

The point here is that the franchisor receives their royalty based on gross sales or turnover while the franchisee may not be making a profit !

So, you need to make sure that the franchise opportunity is financially viable to you as a franchisee. This means you can take a reasonable salary for your effort from the business, pay your overheads and interest on any loans and then still return a profit.

It is therefore critical franchisees do objective financial analysis and prepare cash flow projections with their accountant

Tip: If relying on the franchisor’s earnings information, ensure their model makes provision for a salary to the owner /operator before showing a profit.

Working capital

We often find that the working capital requirements are understated by franchisors particularly for a new greenfield site so check with your accountant what would be a reasonable level of working capital to avoid financial stress in the first 6 to 12 months of operation.

Also allow a buffer for unexpected costs which may not be included in the Disclosure Document, such as employees, insurances, utility bills and other outgoings and now lockdown events!

term and renewal

It is likely due to the changes to the Code and franchisees right to seek early termination of the agreement during the term that the days of long-term agreements are over and 5-year terms with options will be the norm

The capital expenditure must be clearly set out in the disclosure documents so the franchisees can budget for those future costs

Sites and territories

Mobile franchises (such as those providing gardening or cleaning services) will generally be granted for a specific territory – listed as a number of postcodes or marked on a map attached to the agreement.

The territory may be exclusive or non exclusive and this should be understood so you are aware if the franchisor or other franchisees can operate in the territory,

Retail franchises (such as cafes or gyms) generally are not allocated a territory just a site from which they operate.

Social media and on-line sales need to be carefully reviewed and set out in the disclosure document.

obligations end of term

Upon expiry or termination of the franchise agreement, the franchisee will usually be required to cease to use the trade marks, deliver up the premises and lease, return all documents relating to the system to the franchisor, all confidential information including customer details, transfer phone numbers, domain names and social media accounts to the franchisor.

The franchisor will often have the right under the agreement to acquire the assets of the business, including a transfer of the lease of the premises (if any) but usually at a nominal written down value and with no regard to any goodwill.

The Code provides that if the franchisee seeks an extension or renewal of the franchise at the end of the term and the franchisor refuses (provided the franchisee is not in dispute) the franchisor cannot then enforce the non-compete clauses against the franchisee unless the franchisor has offered the franchisee compensation.

The new Code amendments now make it even more difficult for franchisors to enforce a restraint of trade provision.

Goodwill

Most franchise agreements provide that any ‘goodwill’ developed in the franchise business remain the franchisors on the basis that the franchisee has only developed its goodwill by reason of the license given by the franchisor to use its system, brand and IP and once that ends there is no goodwill that the franchisee can claim.

Under the new Code disclosure requirements, the franchisor must set out if the franchisee is entitled to retain any goodwill at the end of the term.

The Disclosure Document requires greater disclosure of contact details of franchisees of the system so prospective franchisees should use their 14 day disclosure period to contact existing franchisees and gather feedback about the franchise system from a number of franchisees.

Summary

Do your due diligence on the franchisor just as they do their due diligence on you! Also, remember it is one thing getting into a franchise but it can be difficult getting out of one.

Deciding whether or not to enter into a franchise agreement is a huge step emotionally and financially so seek specialist legal, accounting and business advice before committing.

The best investment is getting the right legal and financial advice before committing to a franchise opportunity so you can make an informed decision.

robert toth I Consultant I Accredited Commercial law and Franchise Specialist mmrb lawyers

www.marshmaher.com.au