It’s easy to get caught up in the excitement of recruiting new franchisees and expanding your franchise system with the belief that you, as franchisor, comply with the Franchising Code of Conduct (Code) and the signed franchise agreements are valid. The decision of the New South Wales Court of Appeal (NSWCA) in the case of Ketchell v Master of Education Services Pty Ltd [2007] NSWCA 161 calls into question the validity of all franchise agreements.
The Code
In line with section 51AE of the Trade Practices Act 1974 (Cth) (TPA) and clause 3 of the Trade Practices (Industry Codes - Franchising) Regulations 1998 (Cth), the Code is mandatory for all participants in the franchise industry. The Code applies to all franchise agreements entered into on or after 1 October 1998 and imposes duties and obligations on both franchisors and franchisees.
Clause 11 of the Code provides, among other things, that:
1) The franchisor must not:
- Enter into, renew or extend a franchise agreement, or
- Enter into an agreement to enter into, renew or extend a franchise agreement, or
- Receive a non-refundable payment under a franchise agreement or an agreement to enter into a franchise agreement,
unless the franchisor has received from the franchisee or prospective franchisee a written statement that the franchisee or prospective franchisee has received, read and had a reasonable opportunity to understand the disclosure document and this Code
2) Before a franchise agreement is entered into, the franchisor must have received from the prospective franchisee:
- Signed statements, that the prospective franchisee has been given advice about the proposed franchise agreement or franchised business, by any of:
- An independent legal adviser.
- An independent business adviser.
- An independent accountant.
- Or, for each kind of statement not received under paragraph (a), a signed statement by the prospective franchisee that the prospective franchisee has either:
- Been given that kind of advice about the proposed franchise agreement or franchised business.
- Been told that that kind of advice should be sought but has decided not to seek it
Ketchell v Master of Education Services Pty Ltd
The case of Ketchell v Master of Education Services Pty Ltd considers whether a failure by the franchisor to obtain these written and signed statements from the prospective franchisee will invalidate an otherwise enforceable franchise agreement.
This case was initiated by the franchisor in the Local Court by way of a claim for liquidated damages of $31,887.71, being 43 monthly fee payments due to the franchisor according to the franchise agreement (franchise fees).
At first instance, the franchisor was awarded the franchise fees and costs on the basis that though the provisions were mandatory, contravention of the Code did not render the franchise agreement illegal.
However, this decision was set aside on the grounds that the Local Court had failed to address the real issue tendered with regard to clause 11 of the Code. The case made its way, via appeal, to the NSWCA.
On appeal, the franchisee asserted that the franchisor was not entitled to the franchise fees as clause 11 of the Code both prohibited the franchisor from entering into the franchise agreement, and the receipt of the payment (being a non-refundable payment) by the franchisor.
Accordingly, the NSWCA was left to determine whether a contravention of clause 11 of the Code by the franchisor rendered the franchise agreement illegal and unenforceable.
In deciding on this issue, Mason P. considered:
- The ordinary rule referred to in the High Court decision of SST Consulting Services Pty Ltd v Rieson (2006) 225 CLR 516 which states:
‘When a statute expressly prohibits the making of a particular contract, a contract made in breach of the prohibition will be illegal, void and unenforceable, unless the statute otherwise provides either expressly or by implication from its language’.
- The general rule referred to in Trade Practices Commission v Milreis Pty Ltd (1977) 14 ALR 623 which states:
‘If the legislature prohibits the making of a contract, the making of the contract does not give rise to an enforceable right or obligation’.
Applying these rules, Mason P. held that the mandatory provisions of the Code when read with the TPA expressly prohibited the making of the franchise agreement where the written statements were not received.
Accordingly, the franchise agreement was held to be illegal and unenforceable and the franchisor was unable to obtain the franchise fees owing to it.
Practical implications
An application for special leave to appeal the decision to the High Court of Australia was filed by the franchisor on 10 August 2007.
Unless the High Court grants leave to appeal and then overturns the NSWCA decision, this case serves as an authority that it is imperative to strictly comply with the Code when entering into a franchise agreement and, in particular, a franchisor must receive the written statements in line with clause 11 of the Code prior to entering into a franchise agreement with a franchisee or a prospective franchisee.
If this is not done, it is likely the franchise agreement will be held to be illegal and unenforceable. This is despite the fact that the franchisor may have otherwise complied with the Code.
We suggest that franchisors, particularly those who do not outsource the handling of their franchise documentation to external lawyers, cause an audit to be conducted to ensure the relevant signed and dated certificates are held on file.
Such franchisors who handle their documentation ‘in-house’ would also be well served to review their document handling processes to ensure that no franchisees attempt to take advantage of the decision by refusing to return the certificates.
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