Executive Summary

In 2023, Dr Michael Schaper (previously Deputy Chair of the Australian Competition and Consumer Commission (ACCC) and the ACT Small Business Commissioner) was asked to review Australia’s main law regulating the franchising sector - the Franchising Code of Conduct (Code)¹ (Review). The purpose of the Review was to evaluate the effectiveness and fitness for purpose of the Code. A trigger for the Review was that the Code was scheduled to sunset in April 2025.  

Dr Schaper’s final report was published in February 2024.  Recently, the Australian federal government responded to that Review report, with the Minister for Small Business, the Hon. Julie Collins MP, announcing that the Australian Government agrees or agrees in principle with all of Dr Schaper’s recommendations (Government Response). The scene is set therefore for the Code to be changed in the next year.

It is no surprise that many in Australia’s franchise sector are fatigued by this latest development, as there has been almost constant tinkering to this key piece of legislation since it was first enacted in 1998 - the Code has been amended at least ten times since 1998 and eight times since it was remade with effect from 2015.

Continual instability in the law has caused regulatory fatigue and more compliance costs.  

Even Dr Schaper commented in his report that “[t]he sector requires some respite from the constant process of review. Reviews of the Code should be conducted at five-year intervals and should involve a mid-term and general sunsetting review prior to remaking”.

Below we explain the key changes expected to be seen in the draft legislation to be brought forward.  

Penalties

The Review considered that the current penalty regime, including the monetary value of penalties for breaches of the Code, should be reassessed. The regulatory framework, with selective breaches attracting penalties, is set to be amended in a way that entails all substantive obligations having a penalty provision. The Review recommended increasing the value of infringement notice penalties to improve deterrence – a recommendation accepted by the Australian Federal Government.

Restraint of trade clauses and goodwill

The Review noted that two issues frequently causing disputation at the conclusion of a franchise agreement are:

1. how goodwill is treated; and
2. restraint of trade (non-compete) clauses.  

Under the Code, franchisees are not automatically entitled to goodwill associated with the franchisee’s business at the end of the franchise agreement term. The Code does however:

• require the mandatory disclosure document provided by the franchisor to include details of the prospective franchisee’s rights relating to any goodwill; and
• render restraint of trade clauses unenforceable in some circumstances if the franchisor has not compensated the franchisee for goodwill and the franchisee wanted to extend the agreement after the term. However, the Code does not outlaw franchisors from including restraints of trade in franchise agreements.  

As a potentially anti-competitive aspect of the franchise agreement (given they may harm competition), there are other limits on the use of restraint of trade clauses under general Australian laws.  The non-compete clauses must be reasonable and proportionate. In some cases, Australia’s unfair contract terms regime may apply. If the unfair contract terms restrictions under the provisions of the Australian Consumer Law apply, the constraint is that the non-compete clause then must not go beyond what is reasonably necessary to protect the franchisor’s legitimate interests and the clauses must be clear and transparently drafted.

Dr Schaper’s view is that “[i]f a franchise agreement is terminated early by a franchisor, through no fault of the franchisee, it appears reasonable to provide some compensation”. He noted that restraint of trade terms often constrain a variety of activity - preventing a franchisee from setting up as a competitor to the franchise brand, often for a specified time and within geographic boundaries, and often attempting to prevent exiting franchisees from soliciting clients, suppliers, staff, and customers associated with the franchise brand in a wide variety of ways.  

Government action in relation to restraints

The Government Response agreed to do the following:

1. Competition Taskforce Review: Direct the Competition Taskforce (which was established by the federal Treasury in August 2023) to seek input on certain non-compete clauses and other restraints so as to allow the Government to gather information on whether further reform is needed in this area. The timing for any new legislation following the consultation process is unclear.
2. ACCC guidance: The ACCC will be asked to produce more guidance on when a restraint of trade provision may be an unfair contract term. The ACCC recently stated that restraint of trade clauses are not inherently unfair, but expressed concern that drafting techniques for them (often cascading restrictions or through a ladder clause) may reduce clarity and transparency.  

Legal minds do differ on what is a reasonable restraint and what is clear drafting for them. The drafting technique commonly used in sophisticated franchise agreements is to have a cascade of restrictions – so that a court, if the matter were litigated, could determine and sever parts of clauses that the court thinks are unreasonable. This leaves the courts to determine which of the balance of restraints are reasonable and so not severed (e.g. a shorter period of time for a restraint of trade or a smaller geographic area for prohibitions against competitive activity). However, the ACCC was worried that the uncertainty of what might be severed (or not, as the case may be) meant that the franchisee did not really know where it stood.

In our view, franchisors are on notice now that restraint provisions must be reasonable and clear. The ladder approach to the drafting of restraint clauses will likely remain as a feature of many franchise agreements for some time until better contract drafting techniques become apparent or legislated.  

Pre-contract disclosure  

Franchisor Disclosure Document and Key Facts Sheet Merger

At present, franchisors have the burden of producing and issuing to franchisees a lengthy franchisor disclosure document (FDD) as well as a shortened “executive summary” style version of the FDD –a “key facts sheet”. These two documents will be merged – in an attempt to reduce the complexity of pre-contract disclosure information requirements.

This is good news, albeit a somewhat ironic development – given that the Australian Government’s motivation for the relatively recent implementation of the key facts sheet requirement was to address how complex and lengthy the FDD usually is. To solve the too-much-hard-to-read-disclosure problem of the FDD, yes, more disclosure was introduced (being the key facts sheet).  

Despite the potential merger of the two documents, we do not predict that there will be a reduction in the amount of content in these pre-contract disclosure materials.

Changes to Franchise Disclosure Register

Another aspect of pre-contract disclosure is the mandatory publication of a franchisor profile in the federal Government’s franchisor disclosure register (FDR). A relatively recent obligation on franchisors (in some circumstances) is to register a profile and provide minimum public information on the FDR,  which can, in turn, be searched and reviewed by prospective franchisees (and competitors for that matter). This aimed to help prospective franchisees before they spent too much time or money pursuing a franchise with a franchisor.  

The Review found widespread unawareness and lack of use of the FDR by the target market of prospective franchisees, with the result that its proposed benefits have not been realised to the maximum extent. The Australian Government is now set to promote the FDR, and will amend it by including in the FDR an obligation on franchisors to provide additional information relating to dispute resolution and adverse actions brought by enforcement agencies against the franchisor.  Examples of additional information to be provided may include whether the franchise system offers binding voluntary arbitration or has been subject to sanctions or court actions involving regulators. Such information may assist prospective franchisees conducting due diligence on franchisors or comparing different franchise opportunities.  

Providing a reasonable opportunity for the franchisee to make a return on investment

One of the more controversial changes is the recommendation that all franchise agreements should give franchisees a “reasonable opportunity to make a return on [their] investment”. Specifically, the recommendation of the Review follows on from past enactment of clause 46B of the Code, which is limited in its application to new vehicle dealership agreements only. That clause requires new vehicle dealership agreements to provide franchisees with a “reasonable opportunity to make a return on investment”.

This obligation on franchisors is set to be expanded in its application to all franchise agreements – and so no longer limited to the motor vehicle dealership sector.

Tenure

The tenure of the franchise agreement is important.  Non-motor vehicle industry franchise agreements are often shorter in duration than those in the motor vehicle industry.  A short term for the franchise grant may not allow a franchisee to receive an adequate return on its initial capital investment – whether or not the franchisor retains ownership of the goodwill accumulated through the use of the franchisor brand and system by the franchisee during the term of the franchise agreement.

Compensation for early termination

The current text of clause 46A of the Code, as applicable to new vehicle dealership agreements only, prohibits a franchisor from entering into a new vehicle dealership agreement unless it contains a compensation mechanism for franchisees in certain circumstances where there is an early termination of the agreement. This is set to be expanded to franchise agreements involving other sectors.

Considering future structure and tenure

In anticipation of the change to the Code foreshadowed, franchisors will need to deeply consider the relationship between the length of the term of the franchise agreement and the compensation for the franchisee (if any) where there is an early termination. The need to provide a franchisee with a “reasonable opportunity” to make a return on investment must be considered when establishing the commercial arrangement and structure.  

Future franchisor licensing regime?  

The Review commented that the franchising regulatory regime differs from the financial services sector.  In contrast to the franchise sector in Australia, in order to conduct a financial services business within Australia, an Australian Financial Services Licence (AFSL) must be obtained. AFSL holders have a general obligation to provide efficient, honest and fair financial services, complying with the conditions of the AFSL and the obligations contained in the federal companies law, the Corporations Act 2001 (Cth). Holding an AFSL, however, does not guarantee the probity or quality of the licensee’s services. 

The ACCC advised the Review that, based on its experience in enforcing the Code, it had formed the view that a licensing system is needed for franchisors. The ACCC advocated for a licensing regime which would require franchisors to obtain approval for a licence to establish or continue to operate a franchise system in Australia, with the licence to provide conditions for compliance. 

Why the ACCC sees advantage in a franchisor licensing regime

Currently, the ACCC acts on breaches of the Code only after harm has occurred. The ACCC suggested the licensing regime would allow it to rapidly and pre-emptively take action to suspend or cancel licences – or to impose conditions on a franchisor’s ability to promote and sell franchises – potentially before harm to franchisees occurs.

The ACCC thought this is necessary to address systemic and persistent issues in the franchising sector in Australia and to lower the ACCC’s enforcement costs, noting it may not be necessary for the ACCC then to issue legal proceedings in court to address conduct issues.  

Ultimately the Review recommended that a comprehensive analysis is undertaken to understand the nature, extent and implications of such a licensing system. This would be a massive change indeed.  

We suggest keeping a close watch on this development.

Motor industry franchising

The current Code’s definition of ‘franchise agreement’ does not unambiguously capture service and repair work conducted by motor vehicle dealerships. The Government Response agreed with the Review to extend provisions regulating motor vehicle dealership franchises to such service and repair work on the basis that these services are an integral part of motor vehicle dealerships.

Next steps 

Those operating in the franchise sector in Australia should keep informed about developments following from the Review and Government Response. At the minimum, we suggest setting aside budgets and anticipating costs in changing disclosure documents and restraint of trade clauses in agreements.

If you have any questions about these matters or need a further briefing or assistance with your franchise documents, please contact one of the key contacts or your usual contact in the Franchising and Distribution practice group in Australia.

1. Competition and Consumer (Industry Codes–Franchising) Regulation 2014 (Cth)