How to change your franchise agreement and stay compliant

Inside Franchise Business: franchisors can make franchise agreement changesChange is crucial to the survival of most things – from studying natural history to learning from the great business leaders of our times. Whether we look to Charles Darwin or Richard Branson for inspiration, the message is the same: evolve or die.

History is littered with great companies that lost their edge: Kodak; Blockbuster; Toys “R” Us. All once at the top of their game, each failed to innovate and adapt to deal with changes in technology and the marketplace.

All companies face challenges with change. It might be taking a risk with a new strategy or getting the stakeholders on-board with a new way of doing things. The same is true of franchised businesses with the added complexity of having to work within the confines of pre-determined terms under a franchise agreement.

So if the starting point is that once a franchise agreement has been entered into the terms cannot be changed, how does a franchisor evolve its system?

Changes via the operations manual

Unless specifically disclosed in the franchise documents, a franchisor may not unilaterally vary the terms of a franchise agreement without the consent of the franchisee.

A franchise agreement will typically set out the key operational and commercial terms that a franchisee must comply with. However, many franchise agreements are drafted in such a way that makes reference to the operations manual for greater detail of those terms.

An example of this is a term in a franchise agreement that says: “The franchisee must purchase the approved products from the nominated suppliers as set out in the operations manual”.

A provision such as this allows a franchisor to vary the suppliers from whom a franchisee must purchase products. The ability to do this is important as, over time, a franchisor may wish to change suppliers for reasons relating to quality control or because it is able to negotiate more favourable commercial terms with other suppliers.

Examples of other terms typically able to be varied by the operation manual are:

  • Menus (if applicable)
  • Approved goods and services
  • Fitout standards
  • Intellectual property
  • Vehicle or signage requirements (if applicable)

Operations manuals are “living documents” that franchisors update from time to time to deal with improvements in the system or changes in the marketplace. Notwithstanding, the recent Unfair Contracts regime has made it more difficult for franchisors to rely on the operations manual as a means of introducing radical changes to how the franchise is to operate or changes that may diminish a franchisee’s rights under the franchise agreement.

Unfair Contract terms

At the end of 2016 new legislation was enacted to protect certain small businesses who enter into “standard form contracts” with businesses for goods and services, subject to the relevant financial and employee thresholds being met. It has been determined that a franchise agreement is a standard form contract and is therefore captured by this legislation.

Franchisors should be wary of varying any terms of the franchise agreement itself or by way of the operations manual, where such terms could be considered “unfair”. To be unfair, a term must:

  • Cause a significant imbalance in the parties’ rights and obligations; and
  • Not be reasonably necessary to protect the legitimate interests of the party advantaged by the term; and
  • Cause detriment (eg, financial) to a party if it were applied or relied on.

If a court determines that a term is unfair, only the term itself is void. The rest of the franchise agreement would remain binding on the parties.

Unless disclosed to a franchisee prior to its entry into the franchise agreement, a franchisor should seek legal advice before making any changes to the franchise agreement that seek to:

  • Introduce new fees
  • Vary or reduce a franchisee’s territory
  • Eradicate a franchisee’s rights to exclusivity
  • Allow the franchisor to terminate the franchise agreement, other than in the circumstances prescribed by the code.

When should you make changes?

Franchisors are required annually to update their disclosure document within four months of the end of the financial year. If you operate under the Australian financial calendar, this means that your disclosure document must be updated by 31 October each year.

This requirement provides the perfect opportunity for you to review the terms of your franchise documents, your model and system on an annual basis. While changes made as part of your annual update will apply to your future franchisees, they cannot be applied to the existing franchisees in your network unless otherwise negotiated with those franchisees.

Under the Franchising Code of Conduct, franchisors are required to disclose in their disclosure document:

  • the circumstances in which the franchisor has unilaterally varied a franchise agreement in the last three financial years, other than variations of a minor nature; and
  • the circumstances in which the franchise agreement may be varied, unilaterally, by the franchisor in the future.

To avoid your franchise system ending up with the woolly mammoth, you need to continually adapt, revise and evolve to keep up with advances in technology or changes in market conditions.

However, you should be mindful of how those changes impact your franchisees and seek legal advice to ensure those changes are made in accordance with the Code and at law.