Franchising FAQs

Q. I am currently looking at buying a franchise and was wondering whether to deal with these types of matters?

Q. Who should your lawyer act for?

A. Your own lawyer should never represent both the franchisor and the franchisee or master franchisee.  Your lawyer should not act in a manner that might give a franchisee the impression the franchisor's lawyer is representing them.

Q. Is a franchise the most appropriate business method for the client?

A. A franchise lawyer should clarify whether or not the franchisor client has considered other distribution options such as agency, distribution, licensing or partnership.

Q. How should a franchisor protect intellectual property?

A. The franchisor should register all elements of the brand including slogans, product names, colour schemes and any other form of registerable intellectual property.  The relevant domain name should also be protected not just in the dot.com.au domain but also in the dot.com domain.  This protection will be helpful in the future when the franchise system is seeking to expand internationally.  The franchisor should also be advised to keep comprehensive records to be able to demonstrate reputation in a foreign country.  This is important if the franchisor wishes to expand internationally.  Trademarks in international markets should also be protected at the earliest affordable opportunity.

Q. What should franchisors do about intellectual property where it is developed by franchisees, employees or contractors?

A. Franchisors should have procedures which enable them to prove that they are the owner of all intellectual property and that no person, particularly a third party or external contractor, is able to claim any interest or entitlement including any moral rights. 

A separate entity should be established to hold intellectual property.  This is particularly important if the franchisor is operating corporate stores or considering international expansion.  It can also make complying with the Franchising Code easier and enable the franchisor to avoid disclosing total group profit.

Q. What is the relevance of the Trade Practices Act 1974 (Cth.) to franchise agreements?

A. Most franchise agreements attempt to impose some form of contractual restriction on the trading freedom of the franchisee.  An example is a franchise agreement that restricts sales outside a particular territory or an agreement that mandates that only certain goods or services may be sold by the franchisee, or an agreement which contains other supply or pricing restrictions. 

The Trade Practices Act imposes severe penalties on franchise agreements that have not been properly considered by legal advisors.  An example is Section 47 (6) which prohibits third line forcing.  In a franchising context, this provision has the effect of prohibiting absolutely any provision in a franchise agreement that requires the franchisee to purchase goods or services from a third party.  Prohibition applies even if the third party is a related party of the franchisor.  Any "approved supplier" type provisions therefore need to be very carefully scrutinized.  Lawyers practicing in this area need to be aware of the structure of Section 47 (6) or use the notification processes under the Trade Practices Act to gain dispensation for conduct.  Section 45 and Section 4D of the Trade Practices Act are also relevant in circumstances where market sharing arrangements are established by competitors.  For instance, where a franchisor distributes goods or services through other channels as well as through the franchise channel, or has a significant number of company stores, it may be that the franchisor and franchisee are competitors.  Accordingly, arrangements in the franchise agreement for exclusive territories and other contractual provisions could breach the Trade Practices Act and expose all parties to substantial fines.  Similar problems can arise where a group of competitors establish a buying group or co-operative.  Another problem relates to the price-fixing provisions contained in Section 45A of the Trade Practices Act.  In simple terms, a franchisor cannot stipulate the prices at which franchisees sell their products.  Franchisors often wish to do exactly this.  Lawyers will need to be able to find ways of achieving the desired commercial objectives without breaching the Trade Practices Act. 

FRANCHISING - REPRESENTING A FRANCHISEE

Q. Is the client suited to being a franchisee?

A. The client should look for one or more of the following characteristics which could mean that they are not suited to being a franchisee:

• If a client has previously been in business for themselves, possibly in the same type of business as the franchise they are looking to buy, this may indicate that they have entrenched ideas and may find flexibility difficult.
• If a client is not prepared to follow systems.  In franchising, for example, it is critical that franchisees are open to and capable of following the systems the franchisor puts in place.  If a person is resistant to change and new ideas, then it is likely franchising will not suit them.
• If a client requires too much assistance such as over-reliance upon a franchisor.  The franchisor is there merely to guide and support franchisees.  The franchisor is not there to run the franchisee's business for them.

Q. What must a potential franchisee receive?

A. The Franchising Code of Conduct requires the information to be supplied by the franchisor to a prospective franchisee.  Under the Code, the franchisor is required to give clients the following legal documents:

• Disclosure Statement
• Franchise Agreement
• A copy of the Franchising Code of Conduct

Under the Code, the client franchisee must have the disclosure document for at least 14 days before signing the franchise agreement or any preliminary agreement or making any non-refundable payments.  For example, the client may be asked to pay a deposit when they lodge the application with the franchisor.  This enables the franchisor to assess whether the client is a genuine prospect.  Provided the deposit is fully refundable, the franchisor may ask for this deposit before the client receives the disclosure document. 

Q. What searches should be done before a prospective franchisee signs the franchise agreement?

A. The franchisee's solicitor should perform a company search of the franchisor.  This will verify that the persons named in the disclosure document as directors and shareholders are in fact correct.  Another search is of the trademarks used in the franchise system.  Searches of intellectual property databases will identify who owns the trademarks.  There are implications where the owner of the trademarks and other intellectual property is someone other than the franchisor.  Other searches include bankruptcy searches of the directors and searches of court registers to ascertain whether the franchisor is involved in litigation.

Q. What information should be looked for in a disclosure document?

A. Essentially, the disclosure document provides a snapshot of the franchise business.  The disclosure document will contain information such as:

• A description of the franchisor, its directors, senior managers and their experience;
• A detailed description of the business being franchised;
• Information about the franchise agreement;
• What payments the client will need to make to the franchisor and to others to establish the franchise business.  Examples are the initial franchise fee, equipment and fit-out costs, security deposits, and working capital;
• What a client can expect to earn from the franchise business;  and
• A list of company-owned and franchised outlets of the business.

Q. What things should be checked before reviewing the disclosure document?

A. The following items should be checked:

• Are all the attachments present?
• Is the disclosure document current?
• Has the disclosure document been signed?
• Are the franchisor's details about business experience present?
• Are there details of any relevant court proceedings or arbitrations involving the franchisor together with information about convictions, judgments or insolvencies of the franchisor or any of its directors?
• Is there a section on a breakdown of the number of franchisors, franchisees and company-owned stores on a state-by-state basis?   One of the most critical parts of a prospective franchisee's due diligence will be making enquiries with existing franchisees.  Accurate knowledge about these franchisees is important in the disclosure document.
  Has the franchisor disclosed relevant information about any intellectual property ownership?
• Has the franchisor disclosed the level of exclusivity which the client can expect from both the franchisor and other franchisees?  For example, in many franchise systems, the franchisee is given an exclusive territory within which they can operate their business.  There is no right or wrong position here.  Rather, lawyers should assess for clients whether the level of exclusivity granted provides adequate protection for the client.
• Has the franchisor disclosed whether the franchisees will be automatically supplied with the stock as they sell?  This section of the disclosure document should also disclose if there are any restrictions upon whom or from where the franchisees may buy goods or services.  It is common for the franchise agreement to provide that franchisees must buy goods or services from the franchisor or its nominated suppliers subject to the provisions of the Trade Practices Act.  One way around this prohibition is where the franchisor supplies the goods/services and the arrangement does not substantially lessen competition.  However, if the franchisees are compelled to buy from either a related company of the franchisor or another third party supplier, then the arrangement constitutes a fundamental breach of the Trade Practices Act.  The only way of overcoming such a breach will be for the franchisor to have lodged a notification with the Australian Competition & Consumer Commission.  By doing this, the franchisor can obtain immunity from action for breach of the Trade Practices Act.  The ACCC will allow the notification so long as the positives of the arrangement (for example consistency of quality of goods or services, or lower prices to franchisees due to bulk buying power) outweigh any negatives (for example, limitation of choice for the clients and customers of franchisees).
• Is there any information about sites or territories?
• Is there any information about any marketing funds and how such funds operate?  This will ensure transparency as far as who is contributing, how much and what the money is being used for.
• Is there information about establishment costs?  Does this information include not just money payable to the franchisor but also money payable to suppliers, plant and equipment and the fit-out of the store, initial franchise fees payable to the franchisor, site related costs such as security deposits or bank guarantees or rent in advance and money required by the franchisee for working capital?
• Has the franchisor given earnings information?  The franchisor does not have to give this information but must include a statement to that effect.  If the franchisor does give earnings information, then a client will need to ascertain what type of earnings information the franchisor has given and assess how it applies to the business being purchased.
• Does the franchise agreement contain the franchisor's financial information?  At least one director of the franchisor is required to sign a solvency statement to the effect that there are reasonable grounds to believe that the franchisor will be able to pay its debts when due.
• Does the franchise agreement clearly establish the nature and extent of the rights being granted?  Is the franchisee being given an exclusive territory or a customer list?
• Does the franchise agreement identify the fixed term of the franchise?  The franchise agreement needs to be of sufficient length to enable the franchisee to recoup the investment and have something to sell down the track.  Most franchise agreements will be for a period of around 20 years.  However, there is a shift more recently towards 15 years. 
• Does the franchise agreement outline what it is that the franchisor will do to support the franchisee both at the start of the relationship and on ongoing basis?
• Does the franchise agreement contain provisions under which the franchisor agrees to provide both initial and ongoing training, manuals, marketing, support etc.?
• What are the franchisee's obligations?  If these are set out in an operations manual, this should be obtained and read carefully.
• What does the franchise agreement say about sales of the franchise?
• Does the franchise agreement provide for the payment of an initial franchise fee?  This should only be between 5% - 10% of the total set-up costs. 
• Does the franchise agreement provide for a royalty sometimes called the management fee, which is payable to the franchisor for use of its system by the franchisee and for ongoing advice and support?  If the franchisor provides administration services such as central booking or invoicing services, there may be some sort of administration fee payable.  This will often be the case with mobile franchises.
• Does the franchise agreement provide for a group marketing fund?   This aspect of the agreement is regulated by the Code.
• Does the franchise agreement contain minimum performance targets which the franchisee is required to achieve?  This will usually apply where the franchisee is given an exclusive territory.
• How can the franchise agreement be terminated?  This is regulated by the Code which sets out a process to be followed if a franchisee breaches the franchise agreement. 
• Does the franchise agreement contain restrictive covenants?  Are the restrictions geographically or temporarily reasonable?
• Does the franchise agreement require the franchisee to organize for guarantees?  This will often occur if the franchisee is a company.  If so, the guarantee needs to be read carefully.  Guarantees may contain charging provisions enabling the franchisor to register a caveat over real estate owned not only by the franchise or company but also by its directors and shareholders.

Q. What else does the Code say about the franchise agreement?

A. The Code provides as follows:

• Seven (7) day cooling off period.
• Requirement for the franchisor to give the franchisee a copy of any lease documents within one month after the documents are signed.
• The franchisor cannot prevent the franchisee from forming an association with other franchisees.
• The franchisor is prevented from including a general release in the franchise agreement.

Q. What should clients do if things go wrong?

A. The legal path of litigation should be the last resort.  The parties should instead focus on commercial resolution.  The Code requires the franchise agreement to set out the procedure for handling complaints.  The parties must follow this dispute resolution procedure.  The person making the complaint must give details to the other party and let them know what they want done about it.  Another option for franchisees is to make a complaint to the ACCC. 

And, in conclusion:

Finally, as a franchise relationship can potentially span a 20 year period, and involve the investment of a significant sum of money, clients should give considerable thought to the numerous issues raised above.