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What is franchising?
Franchising is a method of doing business. It generally involves the grant by one person (called the franchisor) to another person (called the franchisee) of the right to market or distribute products or services under the franchisor's name and system in return for fees paid to the franchisor.
The relationship is usually established under a written franchise agreement, and is governed by the Franchising Code of Conduct which requires certain conditions to be in the franchise agreement and for a disclosure document to be provided to the potential franchisee prior to the sale of a franchise.
Key legal concepts
Some of the terms used in franchising law are explained below.
franchisor means the person who owns or has the right to the name and system, and who grants to others the right to use the name and system in relation to a certain type of business in return for the payment of a fee or royalty;
franchisee means the person who is granted the right to operate a business under the name and system by the franchisor and pays a fee or royalty to the franchisor;
intellectual property means the right to use certain intangible items such as the business name, trade marks, logos, colour schemes, packaging, computer software, patents, designs and trade secrets;
operations manual means the manual supplied by the franchisor to the franchisee detailing the way in which the business is to be conducted. This will usually include requirements for regular reports, uniforms, accounts, signage, appearance of premises, product types, training of staff and management.
Franchising Code Of Conduct means the part of the Trade Practices Act which regulates the activities of franchisors and franchisees.
Common fees and charges
The types of fees payable under a franchise agreement may include:
A franchisee may also be requested to pay contributions towards Yellow or White Pages advertising, franchise group magazines and legal fees of the franchisor.
If you are considering buying a franchise there are a number of things that you should look out for before making your decision. The best way to protect yourself is to know your rights and obtain the maximum amount of information before paying any non‑refundable fee or signing any documentation. Before doing either of those two things, you should ensure you receive from the franchisor a copy of the proposed franchise agreement and a disclosure document and review them carefully.
The information contained in this Outline will help you understand your rights and what you should look out for when considering a franchise.
Types of franchises
There are many different types of franchises, the two basic types are product franchises and service franchises.
Product franchises are where the franchisor has developed an identifiable product of a certain quality and standard. Examples of product franchises are McDonalds, Muffin Break and Sign-a-Rama.
Service franchises are where the franchisor has developed a particular type of service including methodology for providing the service. Examples of service franchises are LJ Hooker, Fernwood Fitness Centres, Snap Printing and Fastway Couriers.
Both types of franchise involve the licensing of the use of a trade name and the provision of detailed advice and support in conducting the business. The franchise may also involve group advertising and promotion, training and specialised software. In some cases the franchisor will actually supply the products to the franchisee for sale.
The relationship between the franchisor and the franchisee is governed by the franchise agreement and any other documents related to that (for example a lease of the site from the franchisor or a separate software licence).
The Franchising Code of Conduct
The Franchising Code of Conduct (the Code) came into force on 1 July 1998 and applies to all "franchise agreements". The definition is very wide and covers most common franchising arrangements. The Code requires the following:
A franchisor must provide a disclosure document to a prospective franchisee at least 14 days before they enter into the franchise agreement or pay non‑refundable money under the agreement. The disclosure document must be updated annually and within 60 days of a franchisor becoming aware of a materially relevant fact.
A franchisor must provide an updated copy of the disclosure document within 14 days to a franchisee if the franchisee makes a written request.
A franchisee must also provide a shorter form of disclosure document to a potential purchaser of its franchise.
The information required to be included in the disclosure document is set out in the Code.
You should ensure that you read the disclosure document provided by the franchisor carefully as it contains information about the experience of the franchisor, previous franchisees, any litigation or criminal proceedings against the franchisor and provisions of the franchise agreement.
Terms of the agreement
The Code sets out certain conditions which govern the terms of the agreement including a procedure for assignment, termination and dispute resolution. It also requires the franchisor to provide a 7‑day cooling-off period so that if the franchisee changes its mind within 7 days of signing the franchise agreement, it can get out of the agreement.
The Code requires the provision of advertising and marketing accounts if advertising levies are payable by the franchisee. In addition, the disclosure document must include either a statement of solvency from the directors of the franchisor or a copy of the franchisor's accounts for the last two years.
ASSESSING WHETHER YOU SHOULD BECOME A FRANCHISEE
Before entering into a franchise agreement you should carefully examine your own skills and financial viability to assess whether you are ready to enter into a franchise arrangement. Many people who wish to open their own business see franchising as a convenient way of doing so because they are purchasing a proven business formula and expect support to be provided by the franchisor. However this does not mean that you do not need your own business and management skills. You will essentially be running your own business and need to be aware of the commitment involved.
You should also ensure that you can afford to pay the initial and ongoing franchise fees and other expenses of the business while also retaining some working capital. After reviewing the disclosure document you should have a good idea of what costs will be involved in setting up the business and your accountant should be able to assist you in assessing your own financial position.
Some of the factors that you should consider when evaluating your suitability for a franchise are as follows:
Once you have addressed these issues seriously, you should have a good idea about whether you are ready to take on a franchised business.
WHAT TO LOOK FOR IN A FRANCHISE AGREEMENT AND OTHER DOCUMENTS
To ensure that your interests as a franchisee are protected when entering into a franchise agreement, there are a number of things that you should ensure are covered in the franchise agreement.
Often the franchise agreement will be presented to you as a done thing. You may not be given much opportunity to fully review the agreement or negotiate its terms. Do not be intimidated by this. A franchisor may be engaging in unconscionable conduct if it refuses to reasonably negotiate with you. In addition, under the Code, the franchisor must allow you an opportunity to review the agreement and seek advice about it.
Below are some of the things you should keep in mind when reviewing the franchise documentation.
Does the franchisor provide training?
Most franchisors will provide you with initial training as part of the initial franchise fee. If there is no franchise fee then you should check who foots the bill for the initial training. Also find out whether transport and accommodation to the training venue (if it is not on-site) is covered by the franchisor.
Is there an advertising and promotional fund?
Franchisors will often have a fund into which all franchisees pay a contribution for advertising and promotion of the group name and system. Under the Code, the franchisor must provide you each year with audited accounts for the fund. You should check the franchise agreement to ensure contributions to the advertising fund are kept separate from other payments to the franchisor and that franchisees are consulted about the advertising paid out of the fund.
What amounts do you have to pay to the franchisor?
These may include an initial franchise fee, an ongoing franchise fee (may be fixed or a percentage of turnover), software licence fee, advertising levy, training levy or other payments for group magazines. You may also have to purchase supplies from the franchisor. You should ensure you know exactly how much you have to pay.
Term of the franchise agreement
The "term" is how long the franchise will last for. Check the term of the agreement and whether you have an option to renew it. You should ensure that the term is long enough for you to justify any initial franchise fee. If there is an option to renew, ensure you diarise when you have to give notice to exercise the option. If you are leasing the site from a third party, ensure that your lease is for the same term as the franchise agreement with appropriate options to renew.
Can you terminate or transfer the agreement?
Many franchisors will not allow the franchisee to terminate the agreement before the end of the term. In some cases, they will allow it but the franchisee must give 30 to 60 days notice. Whatever the provision, ensure that you are happy with it and if there is no ability to terminate, you are prepared to complete the full term. Some franchise agreements will allow early termination but only on payment of a number of months' franchise fees. These are effectively a pre-estimation of damages for early termination and will only be upheld by a court if they are reasonable. You should check with your lawyer whether a particular payment is reasonable.
Under the Code, a franchisor cannot unreasonably refuse consent to transfer the franchise. See below for further details about transferring a franchise.
Who is the lease with and who is responsible for lease negotiations?
In some cases the franchisor will own the site on which the business is to be operated and will grant a lease to the franchisee. In other cases the franchisee will be responsible for leasing appropriate premises from a third party and the franchisor may assist in negotiating appropriate premises for the franchisee. You should ensure that even if the franchisor assures you that the premises are appropriate and the lease is on favourable terms, you review the lease and inspect the premises yourself. In the end it is you who will be signing the lease and will be bound by its terms.
Are you required to purchase supplies or services from any particular supplier?
The franchisor cannot lawfully require you to purchase products or services from a particular or a number of nominated suppliers. If a franchisor does engage in such conduct it is likely to be in breach of the third line forcing provisions of Trade Practices Act 1974. In some cases the franchisor may have obtained special permission to engage in such conduct from the Australian Competition & Consumer Commission.
The franchisor may however require you to purchase supplies or products from an approved supplier. This is to ensure that products are of a uniform standard, quality and type. If you wish to purchase supplies from a supplier not already approved by the franchisor you should submit your request to the franchisor for approval. The franchisor should approve the supplier if they can provide goods or services of an appropriate quantity and quality.
Is there any restraint on your business activities during or after the term of the franchise agreement?
The franchisor may stipulate that you may not conduct any other business or be otherwise employed during the term of the franchise agreement. They may also say that you may not have any interest in a business similar to that of the franchise for a period of time after the termination of the franchise agreement. A court will only uphold such a provision if it is reasonable. For example, it is not reasonable for the franchisor to prevent you from using your skills to gain employment or conduct a business anywhere in the world or for a significant period of time. The franchisor will normally be allowed to include a restraint on you undertaking similar activities within the same area as your franchise for a period of one to two years. The exact terms of a reasonable restraint will depend on the market and the type of business in question.
Is there a comprehensive operations manual?
A good franchised business will have a comprehensive operations manual which covers all the important aspects of the franchised business. It will provide for the visions and objectives of the franchise, management of the franchised business, training, use of signs and logos, operation of equipment, dealing with employees, workplace safety, trading hours, uniforms, risk management, dispute resolution and other relevant issues. You should try and obtain a copy of the operations manual for review prior to entering into the franchise agreement.
Do you have to sign a Prior Representations Deed or Confidentiality Deed?
The franchisor will often require a prospective franchisee to sign a confidentiality deed when providing them with information enabling them to assess whether to enter into the franchise agreement. This deed will simply say that you may not disclose any confidential information you learn about the franchise to anyone. Exceptions to such prohibitions are where you need to give information to employees or when you are legally obliged to disclose information.
A prior representations deed is often presented to a franchisee to ensure any representations which the franchisee has relied on in entering into the franchise agreement are recorded for later reference. There will usually be a space in the prior representations deed for you to record anything that was said to you which convinced you to enter into the agreement that is not recorded in the franchise agreement. If such a deed is presented to you, you should ensure you think carefully about everything that has been said to you by the franchisor or its sales people. If you have relied on a particular statement from any of those people and this is not specifically covered in the franchise agreement you should note it in the prior representations deed. That way if there is any dispute about what was promised to you down the track you can refer to these representations.
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