Here we go again …

Posted By on 18/12/15 at 1:11 PM

As Franchisors and advisors we have just undergone a year of significant change in bedding down the new requirements of the Franchise Code and redrafting our suite of documents.

While much remains unanswered about the new regime, including the practical ramifications of the “good faith” relationships parties now must observe, the changes seem somehow more comfortable now, like that pair of new shoes that are worn in. Well unfortunately focussing on good trading in 2016 is not to be our only concern as two new framework changes are rapidly approaching and as diligent advisors we must ask you to consider and act on them.

Joint Employer status
The first of our comments has been highlighted by the significant recent commentary on the 7 Eleven scandal involving the underpayment of franchisee employee wages.

This unfortunate episode remains unresolved with the Franchisor offering a “kinder” commercial sharing of revenue with Franchisees with the expectation of those Franchisee’s carrying the entire burden of underpayment claims by employees. The Franchisor has sought an indemnity on the wage point in exchange for concessions to make franchises more profitable but this has been met with suspicion and the possibility of outright rejection.

The Franchisor through assumed knowledge of the underpayment scheme that gave rise to this problem remains potentially a target for recovery of those shorted wages under class actions by disgruntled employee’s, being joined in actions by its own franchisee’s or under certain statutes (action as an accessory in a contravention of the Fair Work Act refer s.550) where connivance in underpayment issues can lead to direct liability.

The 7-11 system has suffered commercial damage, brand diminishment and relationship damage in a story that may take some time to play out.
There are now references to other systems participating in similar conduct and they too will be under great stress as the story unfolds. Pizza Hut is the latest system to be commented on by the media.

All of the above is to some extent the past and what we need to concern ourselves with is avoiding similar illegal behaviour but also being unwittingly caught up in allegations that the sins of the Franchisee towards it’s staff can be the responsibility of the Franchisor. No system is going to want to be the last line of recovery if a Franchisee does not meet its staff obligations or cannot because of events such as insolvency.

The USA experience
Franchise systems in the USA are struggling, as we speak, with the idea that a key regulator (the National Labour Relations Board) has determined (refer the Browning Ferris case and current investigation concerning McDonalds) that in some circumstances a joint employer relationship exists between the Franchisor and the employee of a Franchisee.

At the recent American Bar Association Franchise Conference in New Orleans (October 2015) the concerns of the Franchise industry were directed to representatives of the Regulator who had the courage to front a very agitated audience.

The Franchise industry argued strongly that the concept of tight control was integral to allowing others to use brands and systems and that if the Regulator was to use that critical “glue” as a reason to shift inappropriate liability onto the Franchisor it might cause a collapse of segments of what is a trillion dollar economic engine employing millions of people.

The Regulator’s response was that:

  1. It did not institute actions against parties but was responsive to complaints;
  2. It would take action against a Franchisor as a joint employer it if was proved to have indirect control or potential control over a Franchisee’s workers terms and conditions of employment;
  3. Proper behaviour and compliance with the law would avoid such action.

Practically what this seemed to recommend to USA franchise systems was that appropriate drafting that loosened some highly prescriptive rights over Franchisee employee management was in the interests of Franchise systems that wanted to avoid being caught up in any regulatory action.

What is the take home message for Australian Franchisors?

On a practical and logical level the message seems to be that proper drafting and correct behaviour will excuse a Franchise system from being the target of last and perhaps best resort if a Franchisee is incorrectly treated as to salary, superannuation, unfair dismissal, sexual harassment, leave entitlements and other matters that form part of the employment relationship.

So, Franchisors, let’s look at the practical steps you should implement now:

  1. Review your franchise document and ensure that the measure of interference the Franchisor claims to exercise over employees is in the area of brand and system maintenance and protection. Demand hygiene, uniforms, good customer service and positive comments but do not have any say about salary terms, work conditions and the like except to insist that the Franchisee must comply with applicable awards and laws.
  2. Review your operations manuals for they can be as suggestive of controls and behaviour as any formal contract. Don’t let mandated procedures concerning employee’s cross the line into a form of employer/employee relationship.
  3. Provide focussed training and later policy releases consistent with the above.
  4. Seek assurances in reporting that employee entitlements are being met.
  5. Use audits to check on the veracity of reporting.

Will the above steps be enough?

Good sense says they should be however there is draft legislation now being proposed at the Commonwealth level to amend the Fair Work Act 2009 that may require more.

The legislation may impose a strict obligation on the Franchisor to meet unpaid entitlements due to workers to effectively provide a stronger incentive on Franchisors to ensure their Franchisee’s comply while this proposal (an initiative of the Greens may fail or be substantially watered down the 7-Eleven scandal may provide broad political support.

A likely compromise in the climate of the Liberal platform of encouraging business is to make liability dependant on the documentation and the circumstances rather than a strict liability position.

Unfair Contracts Law
The second “framework” change relates to the Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act 2015 (Unfair Contracts Act) which has passed the Commonwealth Parliament and will apply to contracts entered into or renewed after 12 November 2016.

While this is some 12 months off the necessity to consider this legislation arises now as the scope of the contracts potentially caught by it is very broad and any resulting civil penalties (refer the penalty provisions within the control of the ACCC and the courts under the new Franchise Code as a guide) can be steep in addition to the impact of the changes it will force on the relevant contractual relationship.

The Franchise Agreement
Many franchisors and their advisors have to date taken an inflexible stand over the terms of their template franchise agreement. They want to manage a system where all participants are members under a common contract so attempts by a franchisee to negotiate the overall terms are usually resisted or at best contained in a schedule of “special conditions” attached to the agreement without the main body of the document being affected except in the relevant commercial terms section dealing with payments, development schedules and the like. In other words it becomes a “take it or leave it” contractual framework onto which is loaded Franchisor changes under the Operations Manual provisions.

Enter the Regulator
This comfortable view of franchise negotiations needs to change because of the broad scope of the Unfair Contracts Act.

No particular contract (certainly not franchising) is identified by the Act, rather a broad definition is given to those contracts that will be caught by it which, in the opinion of all commentators to date, is going to catch the vast majority of agreements under the franchise model.

In brief, the finding of unfair terms have, for some time, under the Competition and Consumer Act 2010 (Commonwealth) permitted a court to void contracts for the supply of goods and services to individuals where personal use or consumption is involved. The Unfair Contracts Act will extend this consumer protection to small businesses.

When will the Act apply?
The tests for whether the Act applies are:

  1. Is it a standard form contract? That is before signing will a party be given the opportunity to negotiate its terms?
  2. Does the business employ 20 or less people at the time the contract is signed? Note: all employees whether permanent, part time or casual will be counted.
  3. Are the payment requirements $300,000 or less if a 12 month contract only? or
  4. Are the payment requirements $1,000,000 or less if a longer than 12 month contract is signed?

Note: in calculating the $ amounts above all consideration passing to a party is included, not just $ paid. The calculation will not include future Franchise Fee payments and will be limited to up front and ongoing fixed or specified minimum payments.

Are there unfair terms in the contract?
If one or more unfair terms are found in a contract this will not mean the whole contract will fail. Rather the unfair terms will be void leaving the balance intact. Whether such an outcome leaves a contract sufficiently intact or indeed workable for a franchisor will be an interesting issue in the particular circumstances of a finding.

The questions to be considered to determine if a clause is unfair are:

  1. Does the term cause a significant imbalance between the parties?
  2. Is the term not reasonably necessary to protect the position of the party who has the benefit of it?
  3. Will it cause detriment if the term was enforced? Note: this can be a $ detriment or some other.

There are some statutory exceptions even when all 3 criteria apply. These are quite narrow and include matters such as where another law permits the term.

What are our recommendations?

Existing contracts at 16 November 2016.
Treating the legislation as a problem for the future misses a key point which is that although it applies to contracts entered into or renewed after that date it also extends to variations and extensions of existing contracts after that date.

In our experience the issue of “tweaks” to contracts, let alone amendments on renewal, is more common than one might suspect. Many examples of these alterations can be given but one common example is where a territory in a franchise is temporarily vacated and an existing franchisee is asked to take over or manage that territory. Is this an “extension”? Almost certainly and a matter that will draw in the Unfair Contracts Act terms.

What to do now?
Having determined that the Act is likely to apply some simple steps are suggested.

  1. Get into the habit of negotiating contract terms with a franchisee. This doesn’t mean you end up with a hotch potch document that differs from each other document. Perhaps if it is customised to any significant extent the use of a special conditions schedule will be sufficient together with the establishment of a recordal system that identifies those contracts that stray from your template.
  2. During any negotiation put a concerted effort into explaining to the prospect why the term should remain and how it benefits both parties.
  3. Have the franchisee sign an acknowledgment verified by its solicitor that it has had the chance to negotiate the terms and that the contract in final form is fair.
  4. Have your template agreement reviewed by your franchise lawyer. They will ensure that critical clauses are inserted or addressed. An important example being the inclusion in the Renewal Term provisions of a right in the Franchisor to make appropriate changes to the Franchise Agreement to change terms that may offend the Unfair Contracts Act. Another example that readily springs to mind is the removal of any term that gives the Franchisor the unilateral right to amend a term.
  5. Have a close look with your advisor at your template Disclosure Document to make sure it is open and clear on the rights relating to critical terms such as renewal clauses.

Recent Awards & Achievements
Franchising Law – Law Firm of the Year in Australia – 2015
Global Law Experts has recently awarded KHQ with Franchise Law – Law Firm of the Year in Australia – 2015. Global Law Experts conducts independent research and receives recommendations for such awards by business directors, bar associations and other legal counsel. They received over 100,000 responses this year, so a congratulations is in order for KHQ!

The Best Lawyers in Australia – 2015
The Australian Financial Review publishes a list of Australia’s best lawyers each year, who are chosen through exhaustive surveys. Those who are on the list are selected by their professional peers, and have been recognised as being experts in their field. KHQ wishes to congratulate Peter Buberis and Fiona Gilbert for each being listed!

Who’s Who of Franchise Lawyers 2015
Peter Buberis has been identified as a leading expert yet again in franchising in the International Who’s Who of Franchise Lawyers 2015! Who’s Who Legal identifies leading private practice lawyers from across the globe. In doing so, a professional network is developed for leading practitioners to be recognised, congratulations Peter!

Peter Buberis

Peter Buberis Principal

Peter heads our franchise team.

Peter has extensive experience acting for both national and international franchise systems with a strong skill set around the expansion of franchise systems. ... Read More