The Franchising Code of Conduct is changing. Whilst this is not new news, as the current Code was always due to ‘sunset’ on 1 April 2025, some of the changes proposed to the new Code are quite significant.
In early October 2024, the Federal Government released an exposure draft of the proposed Code, called the Competition and Consumer (Industry Code – Franchising) Regulations 2024 (Exposure Draft).
The Exposure Draft remakes the existing Franchising Code of Conduct and attempts to implement the Government’s response to the 2023 Independent Review of the Competition and Consumer (Industry Codes – Franchising) Regulations 2014 (Current Code) informed by the recommendations made by Dr Michael Schaper. The Exposure Draft also attempts to clarify various clauses (which will now be known as sections) of the Current Code.
In this article, we briefly analyse the Exposure Draft and some of the key changes (and anticipated challenges) set out in the current drafting.
How did we get here?
The Current Code will sunset on 1 April 2025 unless it is remade. In anticipation of this, the Federal Government engaged Dr Michael Schaper to conduct a review of the Current Code and in 2023 Dr Schaper released his comprehensive report (Report).
The Report included 23 recommendations, many of which related directly to the content of the Current Code and its utility in managing the franchisor-franchisee relationship. The Federal Government either accepted, or accepted in principle, all of Dr Schaper’s 23 recommendations and a number of those are implemented throughout the Exposure Draft.
Relevantly, Dr Schaper’s Report acknowledged that the Current Code was generally fit for purpose but recommended that it be remade, largely in its current form. Interestingly, the Exposure Draft has departed from this recommendation given that the proposed drafting significantly alters the structure of the Current Code and implements a new form of disclosure document.
Our previous article about Dr Schaper’s Report can be found here.
Transitional provisions
The Current Code will be repealed on 1 April 2025 and the proposed new Code will commence on that date. However, unlike in previous iterations of the Code, there is currently no transitional provisions.
Understandably, the new Code will apply to franchise agreements that are entered into on or after 1 April 2025.
Once the Current Code is repealed, Annexure 1 (being the form of the current disclosure document) will also be repealed. Section 19(3) of the Exposure Draft requires franchisors to create a disclosure document in the form and order of Schedule 1 of the Exposure Draft. We discuss the form and order of Schedule 1 later in this article, but given that it does differ from the current Annexure 1, this will mean that any current disclosure document will soon become non-compliant with the Exposure Draft.
Unlike the Current Code, there is no equivalent to section 5 of the Current Code in the Exposure Draft, which made it clear that an existing disclosure document created prior to commencement of the Current Code could continue to be used. If the intent is that current disclosure documents will not need to be updated immediately, this will need to be clearly stated (ideally by inclusion of a clause similar to section 5 of the Current Code). Otherwise, franchisors should assume that they will be required to update their disclosure document for use as and from 1 April 2025.
Key changes
The Exposure Draft includes a raft of changes to the Current Code.
Structure and numbering
One obvious change is its structure. Unlike previous versions of the Code, the new Code will sit as a chapter within the applicable regulations.
Further, while many clauses from the Current Code are included in the Exposure Draft and remain unchanged, the numbering of the clauses has changed significantly. To assist in navigating these structural changes, the old clause has been included in square brackets next to the new section in the Exposure Draft. We set out a ‘cheat sheet’ guide outlining the clause references in the Current Code and the corresponding sections of the Exposure Draft in Schedule 1 of this article, click here to access.
New ‘Purpose’ definition for the Code
Section 2 of the Exposure Draft substantially changes and expands the “purpose” of the new Code which aligns to Dr Schaper’s third recommendation, that is to insert a clear statement of purpose within the new Code.
Providing clarity of expression to match the policy intent of the Code is welcome but the expansion of the ‘purpose’ definition under the new Code may have significant consequences for franchise litigation in the future where Courts are often required to interpret the conduct of franchisors, as against the Code.
Civil penalties
Consistent with Dr Schaper’s twenty second recommendation, it is proposed that the ‘super penalty’ regime (where the potential penalty a Court could impose is the greater of $10 million, or if the court can determine the value of the benefit, 3 times that value or if the Court cannot determine the value of the benefit, 10% of the adjusted turnover for the past 12 months) will be extended to a number of additional circumstances, including the new obligations relating to providing a reasonable opportunity to obtain a return on investment and compensation for early termination.
Likewise, under the Current Code, only a handful of clauses were actually civil penalty provisions. The Exposure Draft proposes to expand this so that a number of additional obligations will now become civil penalty provisions. For instance, section 51 (formerly clause 26B), which allows a franchisee to request a termination, and requires a franchisor to either accept that request or provide reasons as to why it proposes to reject that request, is now proposed to become a civil penalty provision.
Compensation and Return on Investment
A significant change, (but aligns with Dr Schaper’s ninth recommendation) is that franchisors must not enter into a franchise agreement unless that agreement provides for a buy back/compensation mechanism if the agreement is not renewed or is terminated before it expires in circumstances where the franchisor withdraws form the Australian market, rationalises its network in Australia or changes its distribution model in Australia (see section 42 of the Exposure Draft).
This drafting largely adopts existing language already in the Current Code but which is currently only applicable to motor vehicle dealers, and was specifically introduced following Holden’s exit from the Australian market. It remains to be seen what ‘rationalising’ may mean, or what degree of change to a distribution model is required to trigger the operation of this section. We expect further lobbying to Government on this particular aspect of the new Code, so whether the final Code will reflect the Expose Draft remains to be seen.
This is a significant change for all franchisors and will shift the risk profile when a franchise agreement is not renewed or is otherwise terminated. Compounding the risk for franchisors is the inclusion of a ‘super penalty’ for non-compliance with this obligation.
Another significant change is proposed in new section 43. The new section requires that a franchisor must not enter into a franchise agreement unless the agreement provides the franchisee with a reasonable opportunity to make a return on investment, during the term of the agreement, on any investment required by the franchisor as a part of entering into, or under, the agreement. Again, this section adopts language used in the Current Code with respect to motor vehicle dealers. Franchisors and their advisors will need to carefully consider this provision, and unless further clarification or amendments are made to the Exposure Draft, some degree of uncertainty will exist until there is clarification from the Courts. For example, does a ‘return on investment’ mean some profit margin above bank cash rates? Or some multiple of earnings, if so, how much?
The requirements of this clause will be a balancing act for franchisors – weighting up tenure, against costs and the ‘opportunity’ for a franchisee to obtain a return on those costs. If it is critical machinery required to operate the business, what does a ‘return on investment’ mean and how does it interplay with significant capital expenditure, which is a concept already enshrined in the Current Code.
Disclosure and Process (including Opt Out Rights)
Dr Schaper recommended that pre-entry information to prospective franchisees should be simplified and consolidated. Further, he recommended that franchisor disclosure obligations in relation to existing franchisees should be simplified. These recommendations were widely applauded by the franchise sector but as we comment below, the current drafting may fall short of the simplification that Dr Schaper anticipated. However, and relevantly, the Exposure Draft removes the requirement to create, update and provide to prospective franchisees a Key Facts Sheet.
The Exposure Draft proposes to allow existing franchisees to ‘opt out’ of receiving certain documents. Consistent with Dr Schaper’s seventh recommendation, the Exposure Draft attempts to carve out which franchisees are eligible to rely on the ‘opt out’ provisions. Eligible franchisees are those who have, or have recently had, another franchise agreement with the franchisor that is the same or substantially similar as the Franchise Agreement and who are seeking to franchise a business that is the same or substantially similar as the business that is, or was the subject of, the other Franchise Agreement. While it is acknowledged that the Exposure Draft intends to simplify future disclosure processes, the absence of clarity in section 22(3) of the Exposure Draft as to what ‘substantially the same‘ means in practice will prove challenging for the industry. For example, it is not clear whether a business operating from a stand-alone bricks and mortar location will be considered ‘substantially the same‘ as a business operating under the same brand but from a kiosk location and with a slightly narrower menu. It is also not clear what period of time ‘recently’ is intended to capture.
Further, as the section is currently drafted, the onus is on the eligible existing franchisee to write to the franchisor and opt out of receiving disclosure documentation.
Noting these challenges, we expect that many franchisors will continue with their current, standard disclosure practice of issuing all documents – this will maintain efficiencies and minimise risks to franchisors as to whether the requested ‘opt out’ is code compliant.
Interestingly, the proposed new section 22(6) expressly provides that the franchisor must not sign the franchise agreement until the 14 day disclosure period (now referred to as the ‘Consideration Period‘) has ended. In contrast, clause 9(1) of the Current Code places the obligation on both parties to refrain from entering into a franchise agreement, stating that a franchisor must issue disclosure documentation at least 14 days before they enter into a franchise agreement.
Another change to disclosure obligations is the amending of clause 17 of the Current Code (Disclosure of materially relevant facts). Under section 33 of the Exposure Draft, Franchisors will now have an obligation to disclose proceedings by a public agency alleging certain contraventions of the Fair Work Act. This may become increasingly relevant as Fair Work becomes more active in the franchise sector.
Cooling Off Changes
A further disclosure process change relates to the cooling off period – but again, only for eligible, existing franchisees. Under the Exposure Draft, existing franchisees can opt out of the cooling off period. This might be of use in the case of a transfer (where the transferee has another franchise agreement with the franchisor) but it is unclear how this will work in practice. The drafting again speaks about the franchisee having another franchise agreement with the franchisor for a business that is the same or ‘substantially the same‘ to the original business. The Explanatory Statement accompanying the Exposure Draft tells us that the other agreement is intended to relate to the same or similar business located at another site or location, but such clarification is absent from the actual drafting of the Exposure Draft. We anticipate that based on the wording of section 49, franchisors are likely to err on the side of caution, and require existing franchisees to only commence operation once the cooling off period has lapsed.
ASBFEO – Name and Shame Powers
The proposed section 15 outlines the functions of the Australian Small Business and Family Enterprise Ombudsman (ASBFEO).
Relevantly, the Exposure Draft now contemplates ASBFEO being able to publicise the names of franchisors who refuse to engage in, or who withdraw from, an ADR process for a dispute. This is further elaborated on in section 75. These clauses are consistent with Dr Schaper’s eighteenth recommendation. Franchisors who may have legitimate grounds not to engage in an ADR process will need to carefully consider such an approach, and will need to actively engage with ASBFEO as to their reasons to avoid being publicly named.
Advisor Certificates
A clarification has been proposed at section 26 (which is covered by clause 10 of the Current Code) to make it clear that a franchisee’s advisors do not have to sign a code certificate. Instead, a franchisee can itself sign a certificate to confirm that it has obtained advice from a particular advisor, without that advisor also signing. The drafting of clause 10 of the Current Code has sometimes created confusion, as it did not make it clear whether advisors were required to sign advice certificates. The clarification in section 26 of the Exposure Draft will hopefully speed up the execution of franchise documentation by circumventing (if necessary) advisors’ signatures.
Record Keeping Clarifications
The new Section 36 emphasises the importance of a franchisor’s record keeping practices by amending the drafting of clause 19 of the Current Code to clarify that all documents required to be provided by franchisees under the Code must be kept for 6 years after the franchisor receives that document. Similarly, if a franchisor makes a statement or claim in its disclosure document and relies on supporting documentation to make that statement, the supporting document must also be kept for at least 6 years after the disclosure document was most recently provided to a franchisee. Demonstrating the significance of this obligation, is the introduction of a civil penalty to this obligation.
Marketing Funds – Specific Purpose Funds
An unexpected change is proposed in section 30 of the Exposure Draft. The concept of marketing funds has been broadened and is now rolled into the term “specific purpose funds”. In short, specific purpose funds are intended to capture any payment arrangement where the franchisor requires the collection of money from franchisees for a specific common purpose. This will now capture something like conference fees pooled together to fund the system’s annual conference. The obligations that currently relate to marketing funds will now extend to these specific purpose funds. Practically, this could be a significant issue for some networks as it will now deem certain funds taken from franchisees to be subject to the stringent reporting and auditing requirements currently only imposed on marketing funds. Franchisors will need to ensure that such monies are quarantined in separate accounts and expenses are documented in a similar manner as funds kept within a marketing fund. Similarly, systems that don’t have marketing funds (and those that have actively avoided them) but collect monies from franchisees for specific common purposes may find themselves having to report upon and audit these funds as if they did have a marketing fund.
Terms of franchise agreements
Division 3 of the Exposure Draft sets out a number of items that must, and must not be, included in a franchise agreement. Much of the detail reflects the Current Code, but there are a few key changes (including, as noted above, in relation to new clauses about compensation and return on investment).
First, new section 41 (formerly clause 23) relates to the prohibition of imposing a restraint in a franchise agreement if the agreement is not renewed and certain other conditions have been satisfied. Previously, if a franchise agreement included a restraint, and the conditions were met, the restraint would simply be of no effect. However, the Exposure Draft proposes changing this so that a franchise agreement must not include a restraint that would apply if the conditions were met. A civil penalty provision will apply to a breach of this new section.
In addition to the above, a new section 64 seems to have a retrospective effect by applying to existing franchise agreements which are not extended and will prohibit franchisors from relying on restraint of trade clauses in the circumstances mentioned in section 41. The inclusion of section 64 suggests that franchisors won’t have to update existing franchise agreements as from 1 April 2025 to address section 41, but will be prohibited from relying on restraint clauses if the circumstances in section 41 are met (which is not a huge change from the current situation).
Termination
Dr Schaper’s thirteenth recommendation was that the provisions relating to termination for serious breaches should be simplified, and that the changes made to clause 29 of the Current Code in 2021 should be revisited.
The Exposure Draft proposes various changes to clause 29 of the Current Code (now sections 54 and 55 of the Exposure Draft).
Clause 29 has effectively been broken into 2 parts:
- the first (which also includes a number of other special circumstances – see new section 54) will predominately relate to breaches where a determination has been made by a relevant authority. In this instance, a franchisee’s right to “appeal” the termination has been removed on the basis that they would have been entitled to appeal this finding as part of a process external to the Code. To rely upon this section, a franchisor must simply give 7 days written notice.
- the second section (section 55) picks up those “special circumstances” that rely on a franchisor making a judgement call (i.e. acting fraudulently or operating the franchised business in a way that endangers public health and safety). Termination under this section is still subject to a franchisee’s right to “dispute” and if disputed by the franchisee, a franchisor must not terminate the agreement before the end of 28 days after the day the dispute notice is given.
These changes do not appear to achieve Dr Schaper’s recommendation to simplify the “immediate” termination process, but rather they will potentially make terminations more challenging, and expose franchisors to increased risk.
New Template for Disclosure Document
While not contemplated by Dr Schaper’s recommendations, a number of changes have been proposed to the template disclosure document.
The form of the disclosure document is set out in Schedule 1 of the Exposure Draft. Schedule 1 largely replicates Annexure 1 of the Current Code, with some key amendments (such as changes to headings). References to the Key Facts Sheet will be omitted and certain information previously captured by the Key Facts Sheet will now be housed in item 9 of Schedule 1. Further, the scope of disclosable litigation events is being broadened to capture proceedings or judgments against franchisors (or its associates) regarding specific contraventions of the Fair Work Act. Schedule 1 has also been amended to capture the change in terminology from ‘marketing funds’ to ‘specific purpose funds’.
Finally, the new form disclosure document captures the additional disclosure items that franchisors must now make in relation to significant capital expenditure, including whether the franchisor will require the franchisee to undertake significant capital expenditure during the term of the franchise agreement. The changes themselves are not significant. However, with the current absence of transitional provisions, it will likely mean that franchisors will need to update their disclosure documents for use from 1 April 2025.
What is missing from the Exposure Draft?
Whilst the Exposure Draft does clarify certain aspects of the Code and will improve disclosure in limited circumstances, some of the proposed changes do not clearly address Dr Schaper’s overriding recommendation to simplify and consolidate the pre-entry information given to prospective franchisees.
An absence from the Exposure Draft is Dr Schaper’s twenty third recommendation regarding the introduction of a licensing regime.
A notable silence was also observed in relation to content required to be updated or confirmed on the Franchise Disclosure Register. It seems that, for now at least, the form of the Franchise Disclosure Register will remain as is.
Time to comment
The Exposure Draft contemplates a number of significant changes to the Current Code, which have the potential to seriously impact most franchisors.
However, the Exposure Draft is still just that – a draft. While franchisors now have a better understanding of the changes they may need to make, we do not recommend re-drafting disclosure documentation and/or franchise agreements until the final form of the legislation is confirmed.
In the meantime, the Federal Government has given interested parties an opportunity to comment on the Exposure Draft. This is an important opportunity to provide feedback on the Exposure Draft. If you are interested in providing your comments on the Exposure Draft, you need to do so by 29 October 2024.
This article is a brief snapshot of the changes being proposed under a new Code. Our National Franchising Team will be hosting national seminars for franchisors where we will canvas the proposed changes in greater detail. If you would like to attend one of these seminars, register your interest by signing up to our database here.
In the meantime, we are happy to discuss in more detail and assist with preparing responses to the Exposure Draft if you are interested in providing your own comments.
Please reach out to any of our team to discuss further.
This article was written by Alison McLeod, Partner, Sean O’Donnell, Partner and Emily Lucas, Senior Associate.
