Unfair Contract Terms and Franchising

On 1 January 2015, a new Franchising Code of Conduct (“new Code”) was introduced requiring Franchisors to update their franchise documents to ensure compliance with the requirements set out in the new Code.

Less than 12 months on, another major update is required in light of the passing by Federal Parliament of the Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act 2015 (“new Act”) which will extend the unfair contract term protections, currently available only to consumers, to small business standard form contracts by amending the Australian Securities and Investments Commission Act 2001 (“ASIC Act”) and the Australian Consumer Law as set out in Schedule 2 of the Competition and Consumer Act 2010 (“ACL”).

The amendments will apply to “standard form” contracts entered into, renewed or varied on or after 12 November 2016 where:

1                 the contract is for the supply of goods or services or the sale or grant of an interest in land;

2                 at least one of the parties is a small business; and

3                 the upfront price payable under the contract is no more than $300,000.00 or no more than $1,000,000.00 if the contract is for more than 12 months.

In the case of a contract being varied, only the varied terms will be subject to the new Act on and from the day the varied terms take effect (“variation day”) in relation to conduct that occurs on and after the variation day.

What is a “standard form” contract?

Usually, a “standard form” contract is one that has been prepared by one party to the contract and is not subject to negotiations between the parties – that is, it is offered on a “take it or leave it” basis.

What is a small business?

A small business is one which employs less than 20 people. Casual employees are not counted in this tally unless they are employed on a regular and systematic basis.

How to determine the “upfront price payable”?

The “upfront price payable” is the amount payable under the contract which is disclosed at or before the time the contract is entered into but does not include amounts which are contingent on the occurrence or non-occurrence of a particular event.

Ongoing royalties are likely not included in calculating the “upfront price” payable” if they are formulated by reference to sales, but may be included if a floor price or minimum amount payable is disclosed.

For contracts which are regulated under the ASIC Act, interest payments are also not included in calculating the “upfront price payable”.

How does this apply to franchising?

In most franchise systems:

1                 the franchise agreements are likely to be considered “standard form contracts”;

2                 the franchise agreements are for substantially longer than 12 months with an upfront price payable often less than $1,000,000.00; and

3                 franchisees employ less than 20 people.

Consequently, the new Act is likely to apply to most franchise agreements.

Provided the above apply, the new Act will give courts the ability to declare terms found in franchise agreements void if they are deemed unfair. The franchise agreement will then only continue to bind the parties if it can operate without the unfair terms.

What is an “unfair term”?

A term of a small business contract is unfair if:

1                 It is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term;

2                 It would cause detriment to a party if it were applied or relied on; and

3                 It would cause significant imbalance in the parties’ rights and obligations arising under the contract.

While a court must be satisfied that all three elements exist for the term to be unfair, the contract as a whole and the extent to which the relevant term is transparent may be considered.

What does this mean for franchising?

All franchisors will need to consider the enforceability of their standard form contracts. Franchise agreements should be reviewed to remove the risk of vital terms being deemed unfair and to ensure the enforceability of those terms.

Disclosure documents should be reviewed to ensure transparency of all unilateral variation rights along with any other terms which cause a significant imbalance in the parties’ rights and obligations under the franchise agreement.

Lastly, a legal risk review should be conducted on all other existing standard form contracts used in the franchise system including (if used) supply contracts and leases.

Contact us for a review of the contracts used in your franchise system to ensure their continued enforceability and compliance.

Further Information

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