On 28 June 2006, the Minister for Small Business and Tourism announced a review (“
the Review") of the disclosure sections of the Franchising Code of Conduct (“the Code"). In announcing the review, she stated that “Over the past few months, a number of concerns have been raised regarding the adequacy of the disclosure section of the Code".
The Review is being conducted by a committee headed by Graeme Matthews, supported by a secretariat from the Office of Small Business. The Committee is charged with reviewing the current operation of Part 2 of the Code (“the Disclosure Provisions") and identifying possible amendments to improve the Disclosure Provisions. Submissions have been invited from the public and the Committee is required to consult with key stakeholders, seek the views of the State and Territory Governments and take into account overseas experiences. The Committee is expected to report by 30 September 2006.
In this article, we examine the issues which have led to the Review, and the likely outcome and effect of the Review for franchisors and franchisees.
The Franchising Code of Conduct
The Code was introduced in 1998 to regulate and strike a balance between the interests of franchisors and franchisees. Under section 51AE of the Trade Practices Act 1974 (Cth) (“the TPA"), the Code is a mandatory code, which means that it forms part of the TPA and that a breach of the Code constitutes a breach of the TPA. Section 51AD of the TPA requires that “a corporation must not, in trade or commerce, contravene an applicable industry code". Section 51AC of the TPA provides that in determining whether a corporation has engaged in unconscionable conduct within the meaning of the section, a Court may have regard to the requirements of any applicable industry code. Accordingly, compliance with the Code is essential for both franchisors and franchisees to ensure that they do not breach the TPA.
One of the main purposes of introducing the Code was to ensure that current and prospective franchisees had ready access to information about the franchising business which they were proposing to buy, or had bought (through the Disclosure Provisions). However, the efficacy of those provisions are the subject of debate between franchisees and franchisors, and it is this debate which has lead to the Review.
The disclosure provisions of the Code
Part 2 of the Code sets out information which a franchisor must disclose to its franchisees and prospective franchisees. These include details of:
- the franchisor, including its name; a description of its business; details of any ‘associated’ company or individual; and the name, position held and qualifications of any director, secretary, executive officer, or partner of the franchisor who is likely to have management responsibilities in relation to the franchise
- the relevant business experience in the past 10 years of any director, secretary or partner of the franchisor who is likely to have management responsibilities in relation to the franchise, and a summary of relevant business experience of the franchisor in the last 10 years
- litigation against the franchisor and directors of the franchisor
- existing franchises in the franchise system
- intellectual property relating to the franchise system
- the site or territory of the franchise, and the franchisor’s requirements for supply of goods or services to the franchisee
- relevant marketing or other cooperative funds
- payments required to be made by the franchisee
- the obligations of the franchisee and franchisor
- other conditions of the franchise agreement
- earnings information for the franchise, and
- financial details including a statement as to the solvency of the franchisor as at the end of the last financial year, and financial reports for the last 2 financial years.
The disclosures must be contained in a written document, prepared by the franchisor in a form which accords with the Code. The franchisor must give the franchisee the disclosure document at least 14 days before the franchisee enters into, renews or extends the franchise agreement, or pays a non refundable deposit. They must also update the disclosure document within 3 months of the end of each financial year and provide it to existing franchisees within 14 days of a request being made by them for the disclosure document. If a franchisor fails to provide disclosure documents as required by the Code, it will be in breach of the Code and, correspondingly, in breach of the TPA.
Do the disclosure provisions work?
The advantages of the Disclosure Provisions of the Code are that:
- they require franchisors to provide information to prospective franchisees about the business
- they require franchisors to update the information available to their franchisees on a regular basis, and
- they enable prospective franchisees to obtain information to help them make an informed decision about whether a particular franchise system is the right business for them.
- however both franchisors and franchisees argue that the Disclosure Provisions create a number of difficulties, or fall short of their intended effect. In particular:
- franchisors argue that the Disclosure Provisions are too onerous, with some disclosure documents needing to be over 80 pages in order to comply with the provisions of the Code.
- franchisees say that the Disclosure Provisions do not prevent a franchisor from including misleading information in their disclosure documents. In particular, franchisees have raised concerns that franchisors misrepresent profit expectations, the viability of a franchise and the level of work required for the franchise to be successful. While the provisions of the TPA prohibit such misleading conduct, franchisees claim that if such behaviour does take place, it is too expensive and time consuming for them to take action against the franchisor, and some accuse the Australian Competition and Consumer Cooperation (ACCC) of failing to take timely steps to prosecute the franchisors on their behalf.
- franchisees also say that the disclosure provisions are not specific enough about the amount and detail of information which a franchisor is required to provide. For example, there are concerns that franchisors often do not include enough information about directors’ experience and history.
A recent report by CPA Australia (“When the Franchisor Fails" - A research report prepared for CPA Australia by the University of New South Wales - January 2006) found that the Disclosure Provisions do not protect franchisees when a franchisor’s business collapses. Franchisees frequently are not creditors of the franchisor and so have no control over what happens to the franchise system.
The same report drew attention to the fact that while the Disclosure Provisions require the franchisor to make disclosures about its own business, the franchisor may be one of an ‘interconnected web of legal entities’ and the franchise system ‘often comprises several discrete but related businesses’. The state of those businesses may affect the franchisor, but the Code does not require the franchisor to make any disclosure about the solvency of these related entities.
These arguments have been supported by recent legal proceedings against franchisors brought by the ACCC. In proceedings against Photo Safe Australia Pty Ltd and others, the Federal Court declared that the managing director misled and deceived 37 small business investors in several ways, including failing to provide franchisees with disclosure documents and other information required under the Code. The directors of the companies were ordered to undergo Trade Practices Compliance Training and to pay a contribution to the ACCC’s costs of the proceedings.
Similarly, in proceedings brought by the ACCC in the Federal Court against Office Support Services International Pty Ltd, the Federal Court declared, amongst other things, that although the company had provided documents to the franchisees which purported to be disclosure documents in accordance with the Code, the documents were incomplete and did not contain details such as prior litigation, business experience and potential earnings. The Court also found that the company had engaged in misleading and deceptive conduct in relation to the representations that it had made in its disclosure documents, and that the director of the company had aided and abetted, or was knowingly involved in, those contraventions. The Court ordered ongoing injunctions restraining the company and its director from engaging in this sort of conduct, and requiring the director to provide people to whom he promoted or sold any future business opportunities with a copy of the orders made by the Federal Court by way of disclosure for a period of 2 years; and certification from a CPA that any financial details or projections were true and correct or based on reasonable grounds, for a period of three years.
Possible outcomes from the Review of the Code
It is likely that the Review will focus on whether the financial information which is required to be given under the Code is sufficient to provide prospective franchisees with the information they need to assess whether a business is viable. If the Committee decides that the current Disclosure Provisions are not sufficient, it is likely that disclosure documents will become even longer, as they will need to contain significantly more information.
Another possible outcome is that franchisors may be required to disclose the names of all entities which are related to it, or which will play a part in the franchise system, so that a prospective franchisee can investigate the solvency of those related entities when deciding whether to proceed.
Thirdly, it is possible that although the terms of reference of the review were restricted to an examination of the Disclosure Provisions of the Code, there may be so many complaints in submissions to the Review by franchisees about other deficiencies of the Code that the terms of the Review may be widened. In a recent article in The Australian newspaper, Peter Switzer foreshadowed that franchisees would complain about the mediation and dispute resolution provisions of the Code, and the services offered by the ACCC to aggrieved franchisees (“Franchising Row Reaching its Climax", Peter Switzer, The Australian, page 22, 5 September 2006).
Conclusion
Whatever the outcomes from the Review, it is likely that even the smallest of proposed changes to the Disclosure Provision will require franchisors to provide significant further information and may also require them to update their current franchise agreements. Given that failure to do so will constitute a breach of the TPA, it is essential that franchisors stay abreast of the Review’s findings. We propose to provide an outline of those findings, and their implications, in a future edition.
