Unfair contract terms: so you updated your franchise agreement for the November 2023 deadline – but have you considered the ACCC’s Report?

In November 2023, Australia’s revised unfair contract terms (UCT) regime took effect. Our article on the regime can be found here.

However, at that time, many franchisors were wondering how exactly the Australian Competition and Consumer Commission (ACCC) would look at, and deal with, franchise agreements in the context of UCTs. Franchise arrangements are clearly very different to, for instance, a standard supply arrangement. Franchisor/franchisee relationships are often very symbiotic, with the parties relying on, and being heavily dependent on, each other. Franchisors usually have strict guidelines relating to the franchise system that a franchisee must follow to ensure a consistent brand/product is delivered by all franchisees. How would the ACCC view these arrangements through a UCT lens?

While the ACCC has previously offered some guidance (see, for instance, the ACCC’s Back in Motion press release and the ACCC’s 2016 report, Unfair terms in small business contracts: A review of selected industries (2016 Report)), in December 2023, we received some additional guidance, following the ACCC releasing its report: Unfair contract terms in franchise agreements (The Report).

The Report

In July 2023, the ACCC commenced a series of compliance checks assessing the documents of 10 franchisors from a variety of industries against the requirements of the Franchising Code of Conduct (Franchising Code) and against the UCT provisions of the Australian Consumer Law (ACL).

Following those compliance checks, the ACCC released the Report in December 2023, finding that the franchise agreements were largely compliant with the Franchising Code, however, they contained a number of clauses that raised UCT concerns.

Noting the timing of the checks undertaken by the ACCC, it is likely that most, if not all, agreements had not had a recent UCT review in preparation for the November 2023 deadline. This is a relevant point to note, as we have certainly seen franchisors adopt a more conservative approach to clauses during recent reviews than may have been the case when the concept of UCTs were first introduced to business to business standard form contracts some years ago.

Key findings and action items for franchisors

The ACCC Report identified 5 key areas of concern.

1. Unilateral variation clauses

The ACCC identified that over half of the franchise agreements contained clauses that permitted the franchisor to unilaterally vary terms. They highlighted 2 particular unilateral variation clauses of concern, being the unilateral right to vary the franchise’s operations manual; and to vary the approved products list and approved suppliers list.

In our experience, most franchise agreements have historically had broad rights to vary both the manual and the approve product/supplier list. This is for a number of reasons including to protect and maintain consistency of the brand, ensure public health and safety and to reflect changes in consumer preferences. The ACCC did recognise that unilateral variations clauses are not automatically unfair, but noted that a clause that allows a franchisor to unilaterally vary important rights and obligations in the agreement is likely to be problematic when it goes beyond protecting the franchisor’s legitimate business interests. In short, franchisors cannot have broad, unfettered rights to unilaterally vary the terms of their agreements.

To minimise the likelihood of a unilateral variation clause being unfair, the ACCC recommended that:

1. such clauses specify the circumstances in which a franchisor may review or make changes;
2. the franchise agreement require the franchisor to provide the franchisee with reasonable notice of a proposed change and give the franchisee a reasonable time to comply with any change;
3. where appropriate, the franchise agreement should give the franchisee the right to negotiate changes and/or when they will take effect; and
4. the franchise agreement should provide the franchisee with a reasonable opportunity to reduce their losses and sell or use goods purchased prior to notification of the change.

Some of these recommendations can be easily actioned; others are more problematic. In particular, item 3 may be particularly difficult to implement in the context of franchising as if the franchisor is trying to roll out a change across the network, it does not want to be in a position that it has to negotiate the change on a case by case basis as this undermines efficiencies and could lead to significant costs and an inconsistent offering and presentation of the brand.

Franchisors need to carefully consider the need and purpose of unilateral variation clauses. If the clause is unbalanced and may cause detriment to the franchisee, the franchisor must consider the legitimate interest the clause is seeking to protect. If the franchisor cannot identify such an interest, or the clause goes beyond protecting that interest, the clause should be amended.

2. Withholding and set-off payment clauses

The second category of clauses that the ACCC raised concerns about were withholding and set off clauses. The ACCC noted that these types of clauses can cause cash flow problems for small businesses and, if relied on, may have detrimental financial impacts on franchisees.

In particular, the ACCC considered that one-sided clauses that enable the franchisor to set off/withhold payment may be unfair, especially where the franchisee has no corresponding rights or is explicitly prohibited from reducing payments when the franchisor owes money.

The ACCC recommended that:

1. franchisors consider if such clauses are reasonably necessary to protect their legitimate interests. It may be that some limitations need to be set out to ensure the clause does not go beyond protecting legitimate interests; and
2. if a franchise agreement does include a withholding/set off clause that:
   1. the clause require the franchisor to provide the franchisee with reasonable notice of its intention to withhold or set-off payments;
   2. where possible, the clause should set out the circumstances where it would be appropriate for the franchisee to withhold payments or set-off; and
   3. where possible, the clause should specify the method by which the franchisee can dispute or seek a review of a decision to withhold payment or set-off.

How such clauses are used differs broadly from franchisor to franchisor. Some never use their set off rights at all; others use such rights on a day to day basis. Franchisors need to carefully consider how they use these clauses (and how they intend to use them in the future) to ensure that their clauses are fit for purpose, not just from a UCT perspective, but also a business perspective. If franchisors are not using these clauses then they should consider removing them. Franchisor’s should remember that the law of equity recognises set off rights which should apply in most franchise situations, so removing a contractual set off right may not be that significant. If franchisors however wish to retain these clauses, they should be reviewed in the context of the ACCC’s commentary.

3. Audit power clauses

Audit clauses (eg the ability to audit a franchisee’s business) were another area of concern raised by the ACCC.

The ACCC considered such clauses were more likely to be unfair where the franchisee is required to pay interest on an underpayment at a higher default interest rate or where they are required to cover all fees and expenses related to the audit. The ACCC recommended that the costs of the audit be proportionate and reasonable.

Overall, the ACCC appeared to appreciate the need for such clauses. The ACCC’s recommendations for such clauses were not excessive and, realistically, are what most networks are probably already doing. However, it is important to make sure that the applicable clauses reflect this.

4. Restraint of trade clauses

Restraint of trade clauses were flagged in both the 2016 Report and Back in Motion matter, and were again flagged in the Report as clauses of potential concern from a UCT perspective.

The ACCC raised concerns not just about the length and breadth (both area and conduct) of clauses, but also the use of ‘cascading’ clauses, which they considered may not be transparent.

The ACCC’s comments on transparency reiterate the importance of ensuring that not just the concept is fair, but the way in which it is conveyed is clear and fair. This might mean using some extra words to explain how something (eg a cascading clause) will apply or work.

In terms of actual content, the ACCC reiterated that restraints that go beyond what is reasonable to protect the franchisor’s legitimate interests are likely to be unfair. Noting this, at a minimum, we recommend revisiting the length and breadth of restraint clauses and considering those in the context of the franchisor’s business and what the franchisor is seeking to protect. For instance, if the franchise network is not in Queensland, and the franchisor has no desire to ever go to Queensland, a restraint that includes Queensland is likely going to be unfair. We also recommend that franchisor’s consider the use of non-solicitation clauses which may be more effective and practical than a simple restraint clause.

5. Termination clauses

Finally, the ACCC identified that termination clauses allowing one party, usually the franchisor, extensive rights to terminate the agreement may be unfair.

Of the 5 types of clauses identified by the ACCC, this is one of the more challenging items, particularly noting that termination clauses are often drafted based on details in the Code. In particular, the ACCC flagged that breach clauses could be unfair if they allow for a breach of any term of a franchise agreement (compared to a material breach). Many franchise agreements likely include a breach clause that does not mention materiality, given that such a concept is not mentioned in clause 27 of the Code – however in light of the ACCC commentary this position may need to be revisited.

Likewise, the ACCC raised concerns about termination for convenience clauses (albeit that they may be contemplated in, although not specifically permitted by, clause 28 of the Code).

In light of the ACCC’s comments, it is important to revisit termination clauses and not simply seek to shelter behind what the Code says about termination. It may not be realistic, practical or commercially sensible to make all termination clauses mutual. However, it is necessary to consider if the current clauses are unfair and, if so, what needs to be done to make them fair. For instance, the ACCC recommends that:

1. the clauses are written in plain language and contain appropriate counter-balancing terms; and
2. franchisees are provided a reasonable opportunity to remedy any potential breach that may give cause to termination.

Conclusion

If you have not already reviewed your franchise agreement and supporting documents, you should do so as a priority. Further, if you reviewed your documents prior to the release of the Report, we recommend going back and having another look at the clauses flagged by the ACCC to ensure that your clauses align with the ACCC’s commentary.

A failure to address UCTs in your franchise agreement and other standard form agreements may expose your franchise system to significant penalties and negative publicity.

HWL Ebsworth has a specialist franchising law team and unfair contract terms team that advises clients in various industries across Australia. Contact a member of these teams for further information.

This article was written by Allison McLeod, Partner and Melissa Ramsden, Special Counsel.