The importance of obtaining up to date and meaningful information from Franchisors
The ACCC report on Disclosure Practices in Food Franchising (“report”) released last year has highlighted many issues which both Franchisors and potential Franchisees in food businesses should be aware of. Whilst the report findings were based on a compliance check of only a small sample of Franchisors, the disclosure made by Franchisors to Franchisees in the area of food franchising was inadequate in many instances.
Although the report only looked into franchise systems for food businesses, many of the recommendations can be applied to all franchise systems.
Disclosure Documents by Franchisees
The report identified numerous areas where potential Franchisees should be seeking further information from Franchisors before committing to a Franchise Agreement and where Franchisors should make additional disclosure to ensure compliance with the Franchising Code of Conduct (“the Code”), including:
(a) Contact details of former Franchisees
Under the Code, Franchisor’s Disclosure Documents must include details of former Franchisees. This is for the purpose of allowing potential Franchisees to contact people who have previously been involved in the franchised business. The report found that commonly only a residential or postal address was provided (and at times only the address of the franchised business or no address at all), meaning a potential franchisee could not make prompt enquiries via telephone or email with a former Franchisee. The report recommends that Franchisors provide contact details where a former Franchisee can be contacted.
As such, Franchisors should ensure personal email addresses, mobile phone numbers and any other up-to-date contact information of former franchisees are included in their Disclosure Documents. Potential Franchisees should use this contact information as a valuable source of inquiry to obtain feedback from a person no longer invested in the franchise system.
(b) Restriction on acquisition of goods and services from suppliers
Commonly Franchisees are only permitted to acquire certain goods and services from approved suppliers. Whilst Franchisors must disclose supply restrictions, the report found that the majority of Franchisors sampled did not adequately disclose what goods were subject to the supply restrictions, with the Disclosure Document commonly referring to the Franchise Agreement or operations manual for details of the restrictions. The ACCC has recommended that Franchisors ensure that they disclose details of the actual goods and services subject to supply restrictions, particularly where those goods and services are essential to the franchised business.
It is extremely important for potential Franchisees to understand what goods and services they must buy from approved suppliers and what goods and services they are free to purchase where they choose. Before investing in a franchised business, potential Franchisees should be asking questions about supply restrictions to understand what products they must buy from approved suppliers and the costs involved.
It is also important for potential Franchisees to understand the impact the supply restrictions may have upon the profitability of the franchised business. Under a Franchise Agreement, a Franchisor may require Franchisees to purchase certain products from an approved supplier, the Franchisor may receive rebates from that supplier and the Franchisor may set the maximum price the Franchisee sells goods or services for. Whilst Franchisors must disclose supply restrictions and any rebates received from suppliers (including whether those rebates are shared with Franchisees), this combination of supply restraints, payment of rebates and setting of maximum prices may have a significant impact upon the Franchise system, including the profitability of individual franchised businesses.
(c) Disclosure of costs incurred in operating the franchise
Whilst Franchisors have an obligation to estimate all costs involved in operating a franchised business in their Disclosure Document, the ACCC found that a third of the Franchisors sampled did not disclose sufficient details of the costs of inventory, rent and wages.
Franchisors should ensure that they provide meaningful estimates of all expenses in their Disclosure Document where those expenses are within the Franchisor’s knowledge or control or reasonably foreseeable. This includes providing estimates of the amounts Franchisees are likely to incur in purchasing inventory, paying rental and paying wage and staff costs.
For potential Franchisees, it is essential that Franchisees understand all likely costs they will incur in establishing and operating the franchised business, including rent, wages, inventory and other associated costs, to allow them to assess the profitability of the franchised business they propose investing in.
Franchisors obligations to update their Disclosure Document
All Franchisors should ensure that their disclosure statements are updated at least once each year (within three months of the end of the financial year) to comply with the Code. When updating their Disclosure Document, Franchisors should ensure the issues raised in the ACCC report are addressed and meaningful information is provided to current and potential Franchisees. Whilst the report addressed food franchises only, the recommendations should be adopted by all Franchisors to ensure their Disclosure Documents provides adequate disclosure.
Prospective Franchisees should carefully review the Disclosure Document provided to ensure they have been provided with all the information set out above and any other information required under the Code. Before investing in a franchised business, it is important to obtain all information in relation to the franchised business and franchise system to allow an assessment to be made about the profitability and the suitability of the franchised business.
Independent Legal and Accounting Advice
Whilst Franchisors are required to notify Franchisees of their right to obtain independent legal advice, the report found approximately 40% of Franchisees did not obtain independent professional advice before entering into a Franchise Agreement.
To ensure potential Franchisees understand the financial consequences of investing in a franchised business, potential Franchisees should refer the financial information obtained from the Franchisor (including in the Disclosure Document and Franchise Agreement), to their accountant to assess the viability and profitability of the franchised business prior to signing any Franchise Agreement.
Franchisees should also refer the Franchise Agreement and Disclosure Document to a lawyer experienced in the area of franchising to obtain independent legal advice. Without obtaining such advice, Franchisees may not have sufficient understanding of the strict obligations placed upon them in operating the franchised business and the consequences of failure to strictly comply with the Franchise Agreement.