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Franchising: What is it and what challenges can be faced?

  1. Introduction
    • Franchising can be an effective lower cost model to expand you business. For a franchisor,
    • For the franchisee, starting a business from scratch can be daunting so there can be strong appeal in buying into a franchise where the franchisor provides a developed way of doing business, ongoing guidance, systems and assistance. It is reported that new franchises tend to have a better success rate than start-ups.
    • In exchange for the franchisor providing the franchise materials, the franchisee is often required to pay a percentage of income or other amount to the franchisor before starting and while running the business, which may also include amounts for the marketing of the franchise and administrative costs.
    • Franchisors and franchisees must comply with the Franchising Code of Conduct (“Code”), which applies to all franchise agreements entered into or renewed after 1 October 1998.
  2. Franchising Code of Conduct
    • Franchising is a special kind of business with significant more administrative requirement imposed by the mandatory Franchising Code of Conduct under the Competition and Consumer Act 2010. In addition to the franchising agreement, the Code requires the franchisor to provide additional information and documents.
    • When commencing a new franchise, a franchisor must give to each new franchisee, at least 14 days before a franchise agreement is signed, an information sheet explaining franchising, a draft franchise agreement, the franchising code, a disclosure document (in the required form) regarding important information about the business and franchisor and a key facts sheet to assist the franchisee in considering the disclosure document. Failure to comply could result in a civil penalty of up to $66,600 per breach.
    • A franchisee who has just entered into a franchise agreement can still exit the agreement during their 14 day cooling off period and get back some of the money they paid to the franchisor. After the cooling off period expires, exiting the franchise is likely to be more difficult.
    • The Code also details the effect of various circumstances of termination, such as where there is a breach of the agreement and the process where the franchisee wants to propose a termination.
  3. Franchising Agreements
    • Franchising agreements have many standard business clauses but there are a number of terms which are unique to franchising.
    • Firstly, many franchises have supply requirements, requiring franchisees to purchase from a particular supplier. This allows the franchisor to maintain quality control but prevents franchisees from shopping around for cheaper or different quality supplies.
    • The Code also modifies or prohibits some standard clauses. For example:
      • Clauses passing on the costs of negotiating and preparing the franchise agreement are prohibited;
      • jurisdiction clauses must have connection with the location of the franchise;
      • it cannot contain a clause requiring the franchisee to pay the franchisors costs in the event of a dispute;
      • creates circumstances when restraint of trade clauses do not apply to the franchisee; and
      • clauses are of no effect if they are a general release of liability or waiver of franchisor representations.
  1. Franchising Disputes
    • Unfortunately, one of the biggest negatives of the franchising expansion model is that the franchisor has significantly less control over the service provided to customer by each individual franchise, which can significantly impact the overall franchise brand. It is a lot harder to get rid of a bad franchisee than a bad employee.
    • A franchise agreement must provide for a complaint handling procedure in accordance with the Code. This procedure provide for the parties to agree to mediation, conciliation or arbitration. If the parties do not agree, then the parties can commence proceedings in the jurisdiction provided for in the franchise agreement.
    • Our lawyers have acted for a franchisor where a new franchisee purportedly terminated the franchise agreement after the first year and just rebranded the store (even being as blatant as to keep using the same materials and just put a sticker over the franchises logo). Obviously, the protection of the franchises intellectual property and investment in training the franchisee in the first year needed to be protected so we commenced proceedings in the Supreme Court and sought an interlocutory injunction to prevent the franchisee from trading.