Franchise Contracts: Avoiding a chain reaction

Franchising is a type of business ownership which allows an individual, partnership or company to operate an independent business under the banner of a business that is already established.

Why franchise?

Franchising offers a number of benefits to both the franchisee and the franchisor. The franchisee obtains the benefit of immediate entry into the market. Typically the franchise arrangement also provides managerial, advertising and administrative support and advice to the franchisee, and also reduces the franchisee’s costs through participation in bulk purchasing and collective advertising. The franchisor, on the other hand, benefits from an injection of funds to enhance expansion.

Franchise agreements

A franchise agreement usually takes the form of a written contract between the parties which outlines the rights and obligations of both the franchisor and franchisee. The franchise relationship is also affected by the Franchising Code of Conduct which has certain provisions regarding disclosure requirements, the conditions of the business (including details of leases, disclosure of materially relevant facts, methods of transfer, termination procedures etc.) and methods of dispute resolution.

A franchise contract is a relational contract. Relational contracts are different from other contracts in two fundamental ways. First, they must be flexible enough to accommodate change. A contract cannot anticipate every contingency in a long-term business association. Many aspects of the franchise relationship change over time. Highly specific, rigid contractual terms are incompatible with the flexibility necessary to maintain the parties’ relationship over the duration of the agreement. Second, relational contracts must balance the needs of both sides in the relationship. If one side takes unfair advantage in the negotiation of the agreement, the resulting one-sided agreement can undermine the relationship permanently. However, in order to protect your interests and take a reasonable position in any negotiation, it is important to have the assistance of an impartial and experienced legal advisor.

Before entering into a franchise agreement, it is important to check the reputation, track record and financial stability of the franchisor very carefully, and to find out what advertising budget and back-up services the franchisor offers and whether they will continue to be supportive after the agreement is signed.

It is also important to obtain legal advice prior to entering into a franchise agreement in order to ensure you understand the effects of all clauses in the agreement.

The agreement should clearly stipulate precisely what fees are payable to the franchisor and how they are to be calculated. It is also important to clarify who has legal responsibility for problems with the product, what the total investment will be, whether some items (like equipment) and the product itself must be purchased from the franchisor, whether there are any restrictions on the location of future franchises in relation to the distance to your location, and what rights the franchisor has to end the agreement. Under the Franchising Code of Conduct, the franchisor must give the franchisee a disclosure document and allow the franchisee at least 14 days to consider the contract before signing.

Regulation

All franchise businesses are required by law to comply with the Franchise Code of Conduct. This Code protects the rights of franchisees and sets out obligations of franchisors. The Code also provides a mediation procedure where disputes cannot be resolved within the franchise system.

The Office of the Mediation Adviser (OMA) helps franchisors and franchisees resolve their problems and disputes without going to court.

Recent case

Franchise agreements can often end in litigation if one side is not satisfied with the bargain that they struck. In New South Wales, aggrieved franchisees have availed themselves of the protection of section 106 of the Industrial Relations Act 1996 (NSW). However that course of action may have been circumscribed by recent decisions of the Commission.

Traditional litigation remains an option, although an uncertain one. For example, the Full Court of the Federal Court of Australia recently allowed appeals brought by the Lenard’s Chicken company and its Master Franchisee, and overturned a high profile decision of the trial judge. The trial judge’s had found that Lenard’s had engaged in misleading and deceptive conduct in relation to documents provided at the time of signing the agreement. The Full Federal Court ordered that this decision be set aside in its entirety.

It is an interesting case, because Lenard’s was a franchise system which had arguably employed best practices in terms of its franchisee recruitment strategies and the documents that it used in the course of the recruitment process. Even so, they lost their case at trial and only won on appeal.

Accordingly, all franchise systems ought to review their recruitment practices very carefully and ensure that they have incorporated clear standards of information into these practices and their franchise documents.

So we recommend you come and see us at Geoff Bartels Business Lawyer before drafting or signing any franchise agreements.

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