‘Fairness in Franchising’ – The Call for Equitable Exit Arrangements

23 May 2019

Chapter 11 of the Parliamentary Joint Committee on Corporations and Financial Services ‘Fairness in Franchising Report’ – published in March 2019 – covered the termination of franchise agreements.

The bulk of the evidence considered by the Committee indicated that franchise exit arrangements are heavily weighted in the franchisor’s favour. As a result, franchisees can be locked into unprofitable businesses and suffer significant personal financial hardship.

In order to address this, the Committee made a number of key recommendations aimed at providing franchisees with more exit rights.

Franchising Code of Conduct (FCC)

The FCC provides for the termination of franchise agreements by franchisors, but not by franchisees. Specifically, a franchisor can terminate a franchise agreement either:

  • by the franchisee’s breach (subject to a franchisee cure right)
  • on reasonable notice, where reasons for the termination are given (where there is no breach by the franchisee)

In addition a franchisor can terminate a franchise agreement where the franchisee:

  • no longer complies with licensing arrangements
  • becomes insolvent
  • is deregistered by Australian Securities and Investments Commission (ASIC)
  • abandons the business
  • is convicted of a serious offence
  • operates the business in a way that endangers public safety
  • acts fraudulently

Significantly the only means by which a franchisee can terminate a franchise agreement in the absence of the franchisor’s agreement are:

  • within the prescribed 7 day cooling off period
  • by not renewing the franchise agreement
  • by having the franchisor acquire the franchised business
  • by transferring the franchisee’s business to a new franchisee

Evidence before the Commissioner was split between those that believed the termination provisions operated fairly and efficiently and those that believed they operated unfairly and oppressively, particularly where the franchisee is required to compensate the franchisor for early termination.

The Committee received evidence about commonplace financial consequences faced by franchisees for early termination of a franchise agreement, including:

  • the franchisor recovering damages from the franchisees, to compensate the franchisor for the franchises not running its full term
  • the franchisee becoming bankrupt or insolvent while still committed to providing substantial cash flows to the franchisor
  • the franchisee, at no fault of its own, being trapped in an unviable franchise with no ability to exit
  • the franchisor having full discretion to decide what constitutes a breach endangering public health or safety or a fraudulent act, both being triggers for termination of the franchise

Submissions

Submissions were received that the FCC should be amended to give franchisees the right to terminate the franchise agreement:

  • on giving 90 days’ notice to the franchisor (with no compensation payable to the franchisor for that early termination)
  • on the grounds of hardship or the suffering of substantial and ongoing financial loss
  • where a prescribed minimum return is not achieved
  • where a franchisor’s action has adversely affected a franchisee

Recommendations

The Committee’s view was, as with many other aspects of franchising, that the FCC reinforces an asymmetry of power in the franchisor’s favour, and when exploited, can result in close to no losses for a franchisor and bankruptcy for a franchisee when exiting a franchise.

Having considered the evidence, the Committee recommended that the FCC be amended to permit franchisees to exit franchise agreements:

  • greater transparency around the allocation (if any) of goodwill in franchise agreements, as well as protections for franchisees when required to undertake significant capital expenditure near the end date of a franchising agreement
  • where the franchised business is unviable (with the test for this to be developed by the Franchising Task Force – it is expected to be based around net profit after tax (NPAT) and/or earnings before interest, tax, depreciation and amortization (EBITDA))
  • in ‘special circumstances’ (such as loss of licence, deregistration, bankruptcy, abandonment, fraud, public safety or environmental searches)
  • in relation to fraud, termination can only occur where the franchisee is convicted of fraud in connection with the operation of the franchise
  • in relation to public health and safety, termination can only occur if the franchisee is given a ‘permanent closure direction’ for the franchise by a relevant government body, or failure to remedy Work Health and Safety (WHS) orders or notices

Equitable exit arrangements are critical to upholding a fair and balanced business relationship. The Committee has recommended significant amendments to the FCC to give franchisees the right to exit franchise agreements taking into account the surrounding circumstances of a franchising arrangement. The Committee anticipates that the amendments would bring about significant cultural change and go some way to extinguishing the power imbalance in franchising.

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