A Franchise Agreement explained
Since the early 1970’s buying and operating a franchise business has become an increasingly popular way for many Australians to own and operate their own business. Initially franchising in Australia almost always involved a foreign parent company or brand. However, today the majority of franchise businesses operated in Australia are home grown.
Just as the number of franchises has continued to rise so too has the array of products and services offered under the franchise model grown from the early days of “Would you like fries with that”. These days franchise businesses offer services as diverse as mowing your lawns, walking your dog or doing your tax returns.
What exactly is a franchise?
A franchise is a business relationship in which the owner of the business that produces the products or supplies the service (the Franchisor) assigns to an independent third party (the Franchisee) the right to use the business name and to market, sell and distribute the nominated goods or service for an agreed period of time.
This is a continuing relationship for an agreed period of time. Ordinarily a Franchisor will be involved on an ongoing basis to ensure that training, marketing (including branding of merchandise) and management are all carried out to an acceptable level by a Franchisee.
Types of franchise models
The two most common models for franchises are:
- Product and trade name franchises – The Franchisee is granted the right to distribute a product manufactured by the Franchisor within a certain defined geographical territory or location. Often royalties or a fee per item is paid for this right; and
- Business format franchises – The Franchisee is granted the right to use a comprehensive system to conduct a business. A wide range of operational matters are covered by the franchise agreement including matters such as the business name, planning, management systems, how the business will look including branding, staff uniforms and premises fit outs and the style and quality of any products or services offered. This type of franchise arrangement depends heavily on consistency and uniformity across all areas of the business as well as extensive standardisation of operational matters.
Franchise agreements often favour the Franchisor
Given that a franchise generally involves a small business person (the Franchisee) contracting with a larger business entity (the Franchisor) it will probably not come as a surprise that most franchise agreements have a tendency to favour the Franchisor.
In order to ensure the ongoing viability of the franchise model it is essential for a Franchisor to retain control over operational and quality standards and for any Franchisee to be able to meet the standards imposed by the franchise agreement.
Applicable Australian Law
Under Australian Law all Franchisors and Franchisees are now required to comply with the Franchising Code of Conduct (“FCC”). The FCC applies to all conduct that occurs on or after 1 January 2015 in respect of all franchise agreements that were entered into, transferred or renewed after 1 October 1998.
In practice, the majority of franchise agreements are for a period of 5 – 10 years (possibly with an option for extension) and are caught by these provisions.
What you need to know before entering into a franchise agreement
If you are thinking about becoming a franchisee, or conversely, thinking that your business model may be suitable to franchise, it is important that you understand the full extent of what is involved.
Prior to entering into a franchise agreement a Franchisee should be provided with certain information by the Franchisor. Franchisees also need to be proactive in undertaking their own investigations into the viability of a franchise.
Some important things to note are as follows:
- When a Franchisee formally applies or expresses interest in a franchise business the Franchisor should provide a short document (statement) setting out the risks and potential benefits or rewards of being involved in a franchise;
- A Franchisor must also provide any would be Franchisee with a disclosure document together with the final form of the Franchise Agreement and a copy of the FCC. These documents must be provided at least 14 days prior to entering into any franchise agreement or the making any non-refundable payment to the Franchisor;
- It is important that both parties to a franchise agreement read each document carefully and obtain legal advice from a suitably qualified and experienced lawyer prior to entering into any agreement or making any payments. Your lawyer will be able to advise you as to whether you should also seek additional advice from an accountant or business adviser;
- For Franchisees it would also be prudent to undertake some pre-entry training.
Beware not all franchises are genuine
It is important for Franchisees to be certain that the Franchisor they are dealing with is genuine. Scams do exist in the franchise world.
The following ‘alarm bells’ should give cause for particular concern:
- Franchisors that promises to help you ‘get rich quick’;
- If the Franchisor is reluctant or won’t provide details of other Franchisees already operating under the franchise model; and
- If a Franchisee is being pressured to act immediately to avoid losing a “once in a lifetime opportunity” or similar hyperbole.
Watch out for ‘churning’
Churning occurs when Franchisors repeatedly sell a franchise site even though the Franchisor would have reasonable reason to suspect or know that the site is likely to be unsuccessful regardless of any individual skills the Franchisee may have or the efforts they may put into the business. If this occurs a Franchisor may be guilty of misleading and deceptive conduct or unconscionable conduct.
It is always far better to seek legal advice before entering into a franchise agreement rather than waiting until there is a problem to be sorted out. Our experienced lawyers are able to assist you at every stage from early enquiries through to documenting and execution of franchise agreements.