16 minute read
Chapter 9 F ranchise Law 101
Chapter 9
FRAN CHI SE LA W 101
About the Author
Raynia is a Principal in the Corporate Advisory and Franchising Team at MST Lawyers and has extensive experience in commercial law, franchising law and leasing law. Raynia acts for many well known domestic retail chains and franchise brands in a variety of industries.
Raynia’s expertise also extends to international franchisors who export to Australia or are considering expanding their operations into Australia. Raynia has been listed as an expert in Franchise Law in International publication Who’s Who Legal since 2015 and in Best Lawyers since 2019.
Wading through stodgy, unfamiliar legal documents for the purchase of a franchise business can be daunting. In this article, we focus on the key legal questions you should consider when investing in a franchise business and reviewing the franchise documentation.
1. What Homework Should I Do Before Buying A Franchise Business?
Conducting adequate due diligence is an essential step before entering into a franchise agreement to ensure that you are fully informed and aware of the risks. As part of proper due diligence, you should:
(a) conduct a basic google search of the franchisor and the particular franchise system which can unearth useful information about the franchisor and the franchisor’s reputation in the market place;
(b) visit the website of the Australian Competition & Consumer Commission (the ACCC). The ACCC is the national regulator of the Franchising Code of
Conduct and makes available on its website a number of resources including:
(i) the Franchisee Manual at https://www.accc.gov.au/publications/thefranchisee-manual
(ii) Franchising: What You Need To Know at https://www.accc.gov.au/ publications/franchising-what-you-need-to-know
(iii)Videos on the risks of franchising at https://www.accc.gov.au/update/ buying-a-franchise-know-the-risks
(iv)Quick Guide to a Franchise Disclosure Document at https://www.accc.gov. au/publications/quick-guide-to-a-franchise-disclosure-document
(c) read the Franchising Code of Conduct (the Code), which is a mandatory code governing franchising at https://www.legislation.gov.au/Details/F2017C00182
(d) analyse the proposed location and/or territory of the franchise business. For example, does the franchisor have a site selection policy and did the franchisor conduct demographic and traffic flow analysis of the site? Is the franchisor planning on expanding within or around the territory, and what rights will you have to purchase any adjacent or competing? Are there any competing businesses within 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.
(e) Read the franchisor’s disclosure document. This document provides important information about the franchisor and the system, including details of the key people involved in operating the system, any current legal proceedings, the estimated costs of setting up and running 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;
(f) (i) (j) approach existing and former franchisees of the franchise system in which you intend to operate and ask them questions to glean first-hand information about the franchisor, how the system operates, the training and ongoing support the franchisor provides and the actual (rather than estimated) costs of running the franchise business. The details of former and current franchisees should be in the franchisor’s disclosure document. The inquiries that should be made should include inquiries in relation to:
(i) how the actual set up costs compared to any estimates provided by the franchisor
(ii) whether any estimates or projections provided in any financial information or profit and loss statements provided by the franchisor proved to be accurate
(iii)the level of support offered by the franchisor, especially to franchisees that are located outside the state from which the franchisor’s head office operates
(iv)whether the franchisor is accessible, organised, responsive to queries as well as suggestions
(v) what is the relationship between franchisees within the franchise system and
(vi)where a franchisee has left the system, the reasons for the franchisee leaving the system.
(g) request financial data or earnings information from the franchisor (or seller), especially if you are buying an existing franchise business. However, a franchisor may be reluctant to provide such information to avoid the risk that it may subsequently be found to be misleading or deceptive;
(h) if you are buying an existing franchise business from the franchisor or one of the franchisor’s franchisees, request a copy of the contract of sale of business, 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 vendor’s statement to the purchaser containing financial and operating information about the franchise business. Even if the vendor is not legally obliged to provide a vendor’s statement, you should nevertheless ask to see the
financial statements of the franchise business for at least the last three years; request a copy of the franchisor’s operations manual to enable you to consider the precise details and procedures governing the day-to-day operation of the franchise business. Given the manual contains confidential information about the system, the franchisor may be reluctant to provide a copy or allow you access to the manual before the franchise documents are signed. As an alternative, you can request that you be allowed to inspect the manual at the franchisor’s head office.
attend franchising exhibitions or conventions;
(k) obtain advice from an independent legal advisor in respect of: (i) the franchise business 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 will have different rights and obligations under such documents 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 licence agreement with the franchisor; and
(iii)your employee obligations under the Fair Work Act 2009 (Cth);
(l) obtain advice from an independent accountant and/or business adviser on the most appropriate and cost and tax effective business structure you should adopt to run the franchise business. Your adviser will be able to advise you as to the best structure to minimise tax and personal risk and protect your assets, such as the family home. The common structures include:
(i) Sole trader;
(ii) Company; (iii)Partnership; (iv)Trust;
(v) Corporate Trust. You will need to make this decision well prior to entering into the franchise agreement so that you and your advisers have sufficient time to prepare the necessary documentation. Some franchisors have policies in relation to business structures that franchisees may adopt accordingly, before spending time and money establishing such structures you should seek the franchisor’s approval of your chosen structure.
2. What Documentation Will I Have To Sign Before Buying A Franchise Business?
The number and length of documents that will be provided to you can be overwhelming. Such documentation will likely include (a) the franchisor’s “Confidentiality Agreement” which you will be required to sign before you are provided with access to any of the franchisor’s confidential documents;
(b) the franchisor’s disclosure document;
(c)
the franchisor’s franchise agreement; (d) the Information Statement that is contained within the Code;
(e) the lease or occupancy licence agreement and disclosure statement in respect of the premises from which the franchise business will be conducted (where relevant); and
(f) “ancillary” documents such as legal advice certificates, acknowledgement forms, representations statements and authority forms.
The law stipulates that you must be given a 14 day “disclosure period” to read, understand and seek advice on the franchisor’s disclosure document, franchise agreement and the Code before entering into the franchise agreement. If, after reading the documents, you do not understand them, you should raise your queries with your legal advisor and/or the franchisor.
You should take comprehensive notes in each meeting or discussion with the franchisor and/or its representatives both prior to and post 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 arrangements agreed to with 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. The Code requires that, before entering into a franchise agreement, a franchisor must obtain from a franchisee a signed statement that the franchisee either obtained legal and accounting advice or chose not to do so.
3. What Fees Will I Have To Pay?
Understanding the financial investment required to operate a franchise business is a key aspect of the proper due diligence and budgeting. As you will discover, there are many one-off and ongoing payments that you will likely incur before purchasing the franchise business, while operating the franchise business and even upon exiting the franchise business. The typical costs include:
(a) an initial up-front franchise fee for the grant of 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 a refundable deposit as evidence of your intent to purchase the franchise business;
(b) equipment costs and if the franchise business operates from fixed premises fitout costs;
(c) initial stock costs;
(d) security deposits or bank guarantees required to be provided to the landlord of the premises and any other occupancy costs (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 sales of the franchise business;
(f) ongoing marketing or advertising contributions or levies. These fees, either a fixed fee or a percentage of the sales of the franchise business, are typically held by the franchisor in a marketing fund to pay for promotional activities on
(i) (j) (l) behalf of the entire franchise network and system. 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 provide a franchisor broad discretion as to the use to which the fund can be put and negate any liability of the franchisor to spend any part of the fund on particular franchisees or their territories;
(g) local area marketing costs: In addition to paying the general marketing fund contributions, under the franchise agreement you may also be required to spend a certain amount of money on your 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 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 sales; 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.
travel costs: Moreover, you will likely be required to bear any travel and accommodation costs associated with training and staff wage costs if your employees are also required to attend training. Franchisors may include the initial training fee within the initial franchise purchase fee. You will need to clarify this with the franchisor;
(k) 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 franchise fee to the franchisor for the right to operate the
franchise business for the further term; 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, in addition to the franchisor’s costs of approving the sale and the new franchisee. Some franchise agreements specify a transfer fee which is calculated according to the year in which the franchise business is sold, with a higher fee payable the earlier the franchise business is sold. It is prudent to bear the transfer fee in mind in negotiating the sale price of the franchise business;
(m)upgrade or renovations costs: if the franchise business operates from fixed premises, the franchisor or the landlord of the premises may require the premises to be renovated or refurbished at your cost. You will need to budget for this from the outset.
(n) legal costs: Franchisors usually require franchisees to pay their legal and
administrative costs incurred in drafting, preparing, negotiating and executing the franchise documentation, including the franchise agreement, disclosure document, lease or occupancy licence and any ancillary documents; and
(o) default costs: Most franchise agreements include a clause requiring you to pay any costs and damages incurred by the franchisor as a result of a breach of the agreement by the franchisee and any enforcement of the franchisor’s rights.
4. Can I Sell My Franchise Business?
You will need to obtain the franchisor’s consent to any sale, transfer or assignment of the franchise business. A franchisor cannot unreasonably withhold its consent to a transfer or sale of the franchise business. However, a franchisor may reasonably withhold its consent to a sale if:
(a) you have failed to pay an amount owing to the franchisor;
(b) you are in breach of the franchise agreement; (c) the purchaser is unlikely to be able to meet the financial obligations under the franchise agreement;
(d) the purchaser fails to meet a reasonable requirement of the franchise agreement;
(e) the purchaser does not meet the franchisor’s selection criteria; or
(f) the purchaser does not agree, in writing, to comply with the obligations under the franchise agreement.
You must also 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 legal costs incurred in reviewing the sale documents, the franchisor’s costs incurred in approving the purchaser as a franchisee, and your own legal and accounting costs associated with the sale.
5. When Can I Terminate The Franchise Agreement?
Unless the franchise arises from a transfer, renewal or extension of an existing franchise agreement, under the Code, you are entitled to a seven day “cooling off period” after you have signed the franchise agreement or made any payment under the franchise agreement. During this period, you may give notice to 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 (less the franchisor’s reasonable expenses). Otherwise, you may only terminate the franchise agreement if the franchise agreement allows you to do so or the franchisor consents to the termination.
It is not common for a franchise agreement to give you any other right to terminate the franchise agreement. Accordingly, if you wish to do so, you will need to seek legal advice to determine whether you have the right to terminate under the general law of contract or under another law. 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. Relatedly, if the franchisor engages 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.
Agreement?
Generally, a franchisor is given more extensive rights to terminate a franchise agreement. For example, a franchisor may terminate a franchise agreement immediately (and without serving prior notice on you) in the following circumstances:
(a) if you breach the franchise agreement and do not remedy the breach within a reasonable time after being given a breach notice by the franchisor to remedy the breach. The franchisor must allow you a reasonable time to remedy a breach. However, this does not have to exceed 30 days;
(b) if you no longer hold a licence that you must hold to carry on the franchise business;
(c) if you become bankrupt or insolvent;
(d) if the franchisee is a corporation and it is deregistered by the Australian
Securities and Investments Commission;
(e) if you are convicted of a serious offence;
(f) if you voluntarily abandon the franchise business or the franchise relationship;
(g) if you operate the franchise business in a way that endangers public health or safety;
(h) if you are fraudulent in connection with the operation of the franchise business; or
(i) if you agree to the termination of the franchise agreement.
A franchisor may also be entitled to terminate a franchise agreement even if you have not breached the franchise agreement if the franchise agreement allows for such early termination, but subject to the franchisor giving you reasonable written notice of the proposed termination and the reasons for it.
7. Can I Operate another Business after the Franchise
Agreement Ends?
Most franchise agreements provide for a “restraint of trade” or “non-competition” period after the expiry or termination of the agreement. This means that you are restrained, or 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.
If you are concerned about how you will be able to earn a living after you cease to operate the franchise business, you should seek legal advice as to whether the restraints in the franchise agreement are enforceable or otherwise try to negotiate a more relaxed restraint with the franchisor.
8. When Can I Renew My Franchise Agreement?
A franchisor does not have to renew or extend your franchise agreement upon its expiry unless you have a contractual right of renewal under the franchise agreement. Therefore, it is important that you try to negotiate an option to renew the franchise agreement for a further term before you sign the franchise agreement.
Despite this, 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. These conditions typically include: (a) you are failing to provide the franchisor with the proper notice exercising the option within the timeframes required by the franchise agreement; (b) you being in breach of the franchise agreement; (c) you are failing to sign the renewal franchise documents within the timeframe required by the franchise agreement; (d) if there is a lease of the premises for the operation of the franchise business, the lease is not renewed by the landlord; (e) you are failing to refurbish or upgrade the premises from which the franchise business is conducted in accordance with the franchisor’s current corporate image and brand; or
(f) you are failing to pay any money owing to the franchisor.
The above explanations aim to give you some preliminary assistance in navigating the legal documents which you will be provided with on the purchase of a franchise business. Although the disclosure document follows a standard format and franchise agreements contain common provisions such as those discussed earlier there is no substitute for conducting your own due diligence, reading the franchise documents thoroughly and obtaining professional advice. Disclosure documents and franchise agreements are complex, lengthy documents and buying a franchise business is a serious undertaking. It is one of the most significant decisions you may make in your lifetime. It is therefore essential that you obtain both financial and legal advice from an accountant and a lawyer who each have significant expertise in franchising. However, it is no substitute for and seeking independent legal and financial advice.
