How to Profit from Franchising

• December 2004

Franchising is a vibrant and significant sector of the Australian business community, with turnover exceeding $80 billion or 12 per cent of Australia's GDP. With over 700 franchise systems serving 19 million people, Australia is the most franchised country in the world per head of population.

A franchise allows a business to run under the name of an already established brand. The franchisor is the company that owns the established brand name. The franchisee is the person who wants to run their business under the established name.

The franchisee, in effect, leases the intellectual property and/or purchases required items for the business from the franchisor.

The Advantages of Franchising

Your products and services are not the only thing you can sell to the public. Your business name, reputation and recognition in the market can be valuable intellectual property.

Even if your business is not particularly well established, if you have an original and successful idea, franchising can take it from a small local enterprise to a nationwide, or even international, market power.

For example, the ‘Boost Juice’ chain has grown from one outlet in 2001 to planning the opening of around its 160th outlet by the end of the year. Through its aggressive growth strategy, Boost has doubled its revenue every three months over the past four years and is expected to report 2004/05 revenue of more than $75 million. The brand now has 90% awareness in Australia, and international aspirations.

Yet little of this growth has come through expensive television advertising or traditional marketing. Much of the success of Boost can be attributed to a successful franchising strategy.

For people contemplating buying or starting their own business, a franchise is a way to ensure instant market recognition and an already established customer base.

Purchasing an emerging franchise is not overly expensive, and allows resources to be pooled for further promotion of the brand. Effective marketing is the key to success in the modern marketplace. However this is something which is often unachievable for a local or independent operator.

The following information outlines the legal rights and obligations of the franchisor/franchisee relationship. It is provided for the benefit of those considering the option of franchising.

The Law and Franchising

Franchising in Australia is very well regulated and is governed by the common law, the Trades Practices Act (‘TPA’), and the Franchising Code of Conduct.

The common law of unconscionable conduct requires franchiser’s to act fairly and reasonably towards franchisees. Franchisors are also subject to the TPA, most relevantly Section 52 which deals with Misleading and Deceptive Conduct. This places a franchisor under a duty to be forthright and honest in their dealings with current or prospective franchisees.

However the bulk of franchisors duties are contained in the Franchising Code of Conduct (‘the code’). This is a mandatory code established under the TPA and as such it has the force of law.

The Franchising Code of Conduct

The code has been operating since 1st October 1998, and is administered by the ACCC. Usually in the case of a breach or complaint from a franchisee, the ACCC will recommend mediation as the first and best option. However, if the franchisor has not been diligent in complying with the Code or is using its superior bargaining power to disadvantage the franchisee, the ACCC may decide to take further action.

The code only regulates those franchise arrangements that fall within the Code’s definition of a “franchise agreement” in Section 4. It is useful to consider this definition when considering the sort of distribution or supply arrangement that is required. The definition is complex, with a number of exclusions, including but not limited to;

  • a partnership relationship, a relationship between an employer/employee, landlord/tenant, mortgagor/mortgagee, lender/borrower;
  • the relationship between the members of a co-operative that is formed under the Corporations Law or any of the state Co-operatives acts.;
  • where the franchisor is a resident outside Australia and only grants one franchise or master franchise to be operated in Australia;
  • where the franchise agreement is for goods or services substantially the same as those previously supplied by the franchisee and the sales under the franchise are likely to provide no more than 20% of the franchisee’s gross turnover.

Main Provisions

The code attempts to regulate the franchising industry and reduce risk by creating a level of certainty for all participants. The main Provisions of the Code are as follows:

Disclosure:

A franchisor is under a duty of disclosure to any current or prospective franchisees. This is discharged through a ‘disclosure document.’

The disclosure document must be provide to a prospective franchisee at least Fourteen (14) days prior to signing a franchise agreement, and must include a copy of the Code and a copy of the franchise agreement.

The information required to be disclosed is extensive, covering 23 categories, it includes details of the franchisor, such as business experience, litigation history, information concerning intellectual property ownership, any supply restrictions, marketing or other co-operative funds, range of costs and payments etc.

The obligation to disclose is a continuing obligation, and as such the franchisor is required to provide disclosure at different times after the agreement has been signed. The franchisor must also issue a disclosure document on request. This obligation continues even after the franchisee has ceased franchising.

Advice before entering into a franchise agreement:

The franchisor must obtain from the prospective franchisee signed statements that the franchisee has been given independent legal advice, or has been told to seek advice but has decided not to seek it. In any event, it is highly desirable for both parties that proper advice is provided, so both sides are aware of their rights and their obligations.

Required provisions in franchise agreement:

All franchise agreements must contain provisions concerning assignment, termination and dispute resolution.

Marketing and other co-operative funds:

The franchisor is to provide financial statements for any marketing or other co-operative funds to which franchisees have made financial contributions.

The code also provides a seven-day cooling off period for the franchisee.

Disclosure requirements have also been scaled back for smaller businesses. In 2001 a short form disclosure document was introduced where a franchised business has an expected annual turnover of less than $50,000. The short form of disclosure document is similar to the longer version, as it only requires a franchisor to disclose 11 of the 23 categories of information. However a franchisor may still have to provide all the information, if so requested by a franchisee.

Further Obligations

Under OHS legislation, the franchisor may owe a duty to see that the business system includes all reasonably practicable measures to ensure the OHS of all persons (employees, contractors, customers and clients, and members of the public) affected by the enterprise.

This is because the franchisor establishes the business system operated by the franchisee and usually requires the franchisee to adhere strictly to the business system.

Understanding Franchisors Obligations

It is important that franchisors understand their obligations. The application of the Code means that the franchise agreement does not act like an ordinary contract, but is subject to outside requirements. Therefore what appears to be simply an exercise of the franchisor’s rights under the franchise agreement, might be subject to further restrictions. For this reason the franchisor needs to understand their rights, and should be mindful of what is owed to the franchisee.

Our legal expertise in this area is underscored by our strong industry awareness and experience, which gives our clients the benefit of accurate, detailed and up-to-date professional advice. Should you have any queries or concerns, please do not hesitate to contact us.

This publication contains general information only. It is not provided as legal advice. Professional advice should be taken before any course of action is pursued, or any information herin relied upon.