4 easy ways to fall foul of Code compliance

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Inside Franchise Business: avoid falling foul of the Franchising Code of ConductDomino’s has been the unlucky business to have been fined $18,000 for the alleged failure to comply with the Franchising Code of Conduct.

The pizza chain missed deadlines for providing an annual marketing fund statement and auditor’s report to franchisees.

The franchisor has issed a statement apologising to franchisees for what it describes as an “honest mistake” and promising to do better.

So we asked Steven Crea at Crea Legal to highlight other simple ways to find yourself on the wrong side of the Australian Competition and Consumer Commission which administers the sector-governing Franchising Code of Conduct.

4 ways to slip into non-compliance

The recent imposition of civil penalties on Domino’s Pizza Enterprises Ltd for alleged breaches of the franchise code serves as an important reminder for all franchisors to ensure that their systems and processes are legally compliant and up to date.

The legal regulation around franchising in Australia is vast and can be quite technical. This is not a substitute for the necessity of having a competent franchising lawyer embedded in the business of a franchisor however there are several ongoing requirements with which a franchisor should be cognisant.

We start with a topic on everyone’s mind this week.

1. The marketing or cooperative fund

Franchisors should not see this as their money, it is money entrusted to them by the network to whom they have a legal onus to handle it responsibility and in accordance with the law. It must be maintained in a separate bank account. If the franchisor operates any stores/units/outlets they must contribute in the same manner as other franchisees.

The disclosure statement must set out key details of the fund including the kinds of expenses for which the fund may be used. This should be revisited each year by the franchisor in the process of review and update of the disclosure document as it may change from time to time.

Clause 15 of the code requires the franchisor to prepare an annual financial statement for the fund detailing all of the receipts and expenses for the last financial year.

This statement must include sufficient detail of the receipts and expenses to give meaningful information about the sources of income and items of expenditure (particularly with respect to advertising and marketing expenditure).

The statement must be audited by a registered company auditor within four months after the end of the relevant financial year. The reasonable costs of administering and auditing the fund may be paid from the fund.

The only exception to the auditing requirement is where 75 per cent of the franchisees who contribute to the fund agree that it need not be audited. This is unlikely to be agreed in most cases.

Keeping full and proper account of the receipts and expenses of the marketing fund is a business critical task of any franchisor operating a marketing fund. If this is managed diligently, the process of preparing the statement and engaging the auditor at the end of the financial year is time and cost effective and should be part of a routine work flow.

Four months is ample time to provide complete this task and provide the report to the network.

Another word of caution about marketing funds is to be consistent with the level of contribution of all franchisees. We have seen many instances were franchisors grant marketing fund concessions to some franchisees and it creates a multitude of problems.

Bear in mind that the disclosure document requires franchisors to state ‘how much the franchisee must contribute and whether other franchisees must contribute at a different rate’.

We are yet to find a franchisee who is satisfied with other franchisees contributing at a lower rate than they do.

2. Disclosure obligations

Other matters which require the ongoing attention of a franchisor and have notification or disclosure obligations include:

  • A change in majority ownership or control of the franchisor (or an associate of the franchisor) or the franchise system. Remember that the definition of associate is quite wide so this may be capture other companies in the group.
  • Proceedings by a public agency, or judgment or award of arbitration against the franchisor or an associate of the franchisor alleging breach of the franchise agreement, trade practices law, corporations law, unconscionable conduct, misconduct or an offence of dishonesty.
  • Numerous other types of judgments against the franchisor or an associate of the franchisor. Additionally, franchisors are required to give details of any current litigation in the franchise disclosure document.
  • A change in the intellectual property or ownership or control of the intellectual property that is material to the franchise system.

The time frame within which notification must occur is within a reasonable time (but not more than 14 days) after the franchisor becomes aware of it.

3. End of term arrangements

A franchisor must notify a franchisee whether it intends to extend the franchise agreement or enter into a new franchise agreement:

  • At least six months prior to the end of the term of the franchise agreement for a franchise term of six months or longer, or
  • At least one month prior to the end of the term of the franchise agreement for a franchise term of less than six months.

The notice must include a statement to the effect that the franchisee may request a disclosure document.

If the term of a franchise agreement is for a fixed term and coming to an end with no option to renew for a further term, this is straight forward.

There are instances where compliance with this notice requirement becomes difficult. Many franchise agreements are not limited to a term of fixed duration and may be terminated by the parties somehow in the future.

Many franchises contain options in favour of the franchisee to renew the franchise which may or may not be exercised, may contain certain pre-conditions and may have to be exercised within a certain time period that may not line up with the Code's requirements.

There are a number of strategies to deal with these situations which a franchisor should work through with their legal counsel.

4. Disclosure document updating

Other than the specific notification requirements stated above, the main compliance task of a franchisor is to update its franchise disclosure document annually. This must be done within four months of the end of each financial year. Note this is the financial year adopted by the particular franchisor and may not necessarily be the year ending 30 June.

The following items are subject to change and need to be updated:

  • The financial reports of the last two years;
  • The marketing fund expenditure for the last year including percentage spent on production, advertising, administration and other expenses;
  • Current franchisee details;
  • Former franchisee’s details unless the franchisor has received a written request that the details not be disclosed;
  • Franchise transfers, terminations, buy-backs, non-renewals, etc. Name, location and contact details of each franchisee must be provided; and
  • Review of costs to ensure they remain current and accurate, both establishment costs and on-going costs.
  • Franchisor officer and associate details particularly relevant if a corporate restructure or change of management personnel has occurred.

Good management of a franchised business dictates that these matters are tracked and recorded throughout the year as and when they occur. This makes the task of annual disclosure document update efficient. Leaving it to the end of the year makes it a more difficult job and increases the risk of overlooking something.

Finally, don’t forget that when granting a new franchise in a territory you have been in during the preceding 10 years, you are required to give details of that franchised business including the circumstances in which it ceased to operate.

In our experience franchising attracts an entrepreneurial crowd due to the commercial appeal it offers. The people drawn to franchising are usually commercially focused and commonly lack appetite for the rigours and expense of compliance.

Fortunately, we are moving ever closer to a situation where strict adherence to the rules is accepted as the only viable means of engaging in the wonderful world of franchising.