Australia s evolving franchising laws: help or hindrance? Australia's franchise law is to apply to foreign franchisors. Should this be a concern?

Australia has traditionally been an attractive market for international franchise systems, specially from the United States. The reasons for this include a similar language and culture, a growing economy and, importantly, a business community which has embraced franchising, which have outweighed the challenges of a smaller population, the tyranny of distance and unfriendly time zones.

That franchising has thrived in Australia cannot be contested. The first major U.S. franchise companies that entered the Australian market in the late 1970s remain, the local franchise association was established in 1983 and a 2006 survey by Griffith University estimated that more than 960 franchise systems operate in the country, 93 percent of these being Australian-based. The same survey noted that 24 franchise companies appeared in a list of the top 500 Australian private companies and more than one-quarter of Australian systems now franchise internationally. Demonstrating the industry's maturity, an increasing number of these are publicly-traded. Despite the language barriers, but perhaps due to the geographic proximity, a number of Australian franchise system are now venturing to Singapore, Malaysia, China and Hong Kong, as well as to the more traditional markets of New Zealand and the United Kingdom. Increasingly, Australia, with its stable economic and political environment and relatively-low costs, is used by international businesses as their Asia-Pacific headquarters.

Have Australia's laws hindered franchising's progress?

Within Australia, as elsewhere, any international business needs to do its homework to check that its goods or services can be exported and marketed in a cost-efficient manner and without material change. Similarly, all agreements to be used in Australia need to be reviewed to determine whether any changes are required or advisable for their use.

Australia's laws have not, to date, contained barriers to entry for foreign franchise systems. While Australia has a federal system, this does not create the challenge to franchising that it does in the United States. Australia has no registration or approval requirements for franchise agreements. It has no layer of "business opportunity" laws which might also apply. It has no barrier to commencing discussions with a potential franchisee which can be caused by a "first personal meeting" disclosure trigger, such as has been the case in the United States. In fact, as discussed below, international franchise companies have enjoyed a special status under Australian law. That is about to change.

Australia has had special purpose franchise legislation since Oct. 1, 1998. This law, a regulation made under Australia's anti-trust and consumer protection legislation, is known as the "Franchising Code." It is both a disclosure and relationship law. When it was introduced, some pundits suggested that franchising would decline as a result. This has not been the case. While growth was slow in the code's first few years, it has been exceptional since 2002. In fact, franchising has continued to grow strongly in Australia since its introduction in the 1970s, despite significant uncertainty over its regulatory status.

The evolution of franchising regulation

While special-purpose franchise legislation was not introduced in Australia until 1998, this was preceded by a 20-year debate regarding appropriate regulation. In the 1970s, two federal government inquiries recommended specific-purpose franchise legislation, including compensation to franchisees upon termination, compulsory disclosure and the regulation of termination, assignment and non-renewal. While these recommendations were not adopted, they were followed in the early 1980s by the regulation of Australian franchise systems as securities under Australia's Companies Act. The late 1980s saw several attempts to draft franchise legislation that was abandoned due to lack of a consensus on an appropriate model. As franchising became more newsworthy and litigation increased in the 1990s, the politicians jumped on board. Numerous government inquiries again considered the case for franchise legislation. A compromise was reached and a voluntary "Franchising Code of Practice" was in place between 1993 and 1996. Finally, riding a wave of federal government support for small business, the new mandatory Franchising Code of Conduct commenced in October 1998. With minor change, it has been in place ever since.

The code requires a disclosure document in a prescribed form to be provided to a prospective franchisee at least 14 days before a franchise agreement or any agreement to enter into it is signed or before any non-refundable payment is made. A compulsory seven-day cooling off period and the requirement to obtain certain certificates from prospective franchisees affect the sales process. The mandatory disclosure document format requires information on 23 subject areas, many of which will be familiar to U.S. franchise companies. The code also affects a number of relationship issues, such as requirements to terminate the franchise agreement, the ability to withhold consent to a transfer and the requirement for mediation of disputes.

Particular relevance to foreign franchisors

The first comprehensive review of Australia's Franchising Code of Conduct was conducted in 2006. While the scope of the review was theoretically limited to disclosure, the review recommended a number of significant changes to various provisions of the code. These are expected to take effect after August 2007. The review recommended the annual registration of franchise agreements and that franchise businesses be prohibited from unilaterally terminating or varying franchise agreements without compensation. While the government did not accept these recommendations, most of the other review recommendations were accepted by the federal government and will be implemented. As draft legislation has not been released, the scope of some of the changes remains unclear.

Of most interest to foreign franchise companies is that the exemption they have enjoyed to date is to be removed. Since the code was introduced, a foreign franchise organization that grants only one franchise or master franchise in Australia has been exempt from its requirements. How this change will affect franchise companies that currently have franchisees in Australia is unclear. It may be that previously-exempted franchise systems will be "grandfathered." However, it is more likely that the exemption will simply be removed, so that the ongoing requirements under the code will now apply to all foreign franchisors.

Other changes which are likely to particularly affect foreign franchise companies are:

* Enhanced financial disclosure. The code's financial disclosure provisions are to be "extended" to include the consolidated entity to which the franchise company belongs. This appears to require two sets of financial information, both for the franchise entity itself and for its consolidated parent.

* Details of past franchisees. Disclosure documents will be required to include contact details of past franchisees. While the government has indicated that this obligation will only apply prospectively and will be subject to the operation of privacy laws, it may be burdensome.

* Continuous disclosure. Disclosure is a continuous, rather than merely an annual, obligation on certain items. The disclosure period for these items will be reduced from 60 to 14 days.

* Marketing fund financial disclosure. Currently franchise firms need not audit their marketing funds if 75 percent of Australian franchisees agree. This exemption is to be removed and the disclosure requirement enhanced to require franchise systems to provide franchisees with a "full account" of the funds, together with the auditor's report.

* Additional disclosure triggers. While the code currently requires a disclosure document to be provided to a franchisee proposing to renew or extend a franchise agreement, this is to be amended to cover both a proposed renewal and an extension of the "scope or term" of a franchise agreement.

* Form of franchise agreement. The form of franchise agreement to be attached to the disclosure document will need to be the form in which it is intended to be executed. While it is expected that the legislature will recognize that changes may be negotiated, the impact this may have on the sales process is to be determined.

* Rebates. Perhaps most controversially of all, the amount or method of calculating rebates, not just whether or not they are provided to franchise systems by suppliers, may be required to be disclosed.

The code's current disclosure requirements are not easily applied to foreign franchise companies in respect of their dealings in Australia. The removal of the foreign franchise exemption will highlight this and may introduce practical complications. The government has been alerted to the practical difficulties these may pose for foreign franchise organizations and the hope is that these will be taken on board. The most notable of these are that the financial disclosure requirements under the code have always been based on Australian accounting standards and audits by Australian registered company auditors and that statistical information regarding franchisees and their contact details and the requirement to audit marketing funds may not to be limited to Australia.

Legal lessons for the Australian market

The removal of the foreign franchise exemption will introduce many franchise systems to Australia's franchise laws for the first time. While the code will require certain changes to their franchise agreements, these are expected to be relatively minimal. The most important change will be the requirement to provide a disclosure document to a prospective franchisee and to provide updated, ongoing disclosure on limited subject areas. Unfortunately, unlike the new exemptions in the United States, Australia does not have any "sophisticated investor" or "insider" style of exemption.

So, can a franchise company providing an Australian disclosure document take comfort that it will be fully-compliant with Australian laws and can freely engage in local franchise sales risk-free? Unfortunately, the answer is no. Analyzing the risks of entering a new franchise market should not start and end with a country's specific franchise laws.

Despite the introduction of the code, the majority of franchise litigation in Australia remains based on representations made as part of the franchise sales process, particularly as to a franchisee's likely turnover or profit. While earnings claims are not prohibited, any representation made in a sales context carries significant risk in Australia: whether or not in a franchising context. Unless entirely justifiable and, in fact, true, such representations can provide a franchisee with an action in damages and a possible way out of an unprofitable franchise contract. Extremely and carefully worded disclaimers can assist, but only in limited circumstances. As a result, a cautious franchise company considering a franchise offering in Australia would be well-advised to obtain as much advice on protecting itself in the sales process as it does on compliance with the local franchise law.

Will the new need for a foreign franchise firm to comply with the code help it manage its legal risk in Australia? Partly. Will it be onerous? Not necessarily. Is the code disclosure requirement the only law which could cause local liability? The answer to this question in Australia, as elsewhere, is no. Risk management and legal compliance must be approached on a jurisdiction-specific basis.

Penny Ward is a partner in the Sydney, Australia office of the law firm Baker & McKenzie. She can be reached at [e-mail].