Changes to the unfair contract terms régime are in effect, and entering into any franchise agreement containing an unfair contact term or relying on an unfair contract term in a franchise agreement could come with significant penalties for franchisors.
Both franchisors and franchisees should review their franchise agreements to ensure they do not contain any unfair contract terms.
What is the current unfair contract terms régime?
As of 9 November 2023, changes to provisions of the Competition and Consumer Act 2010 (Cth) including the Australian Consumer Law came into effect introducing penalties for proposing, using, or relying on unfair contract terms in standard form contracts entered into with consumers and small businesses.
The changes apply to standard form contracts made, varied, or renewed on or after 9 November 2023. This potentially includes a renewal pursuant to a holding over clause.
It is likely that a franchise agreement will be a standard form contract which is subject to the unfair contract terms régime.
Potential unfair contract terms
An unfair contract term is one which:
- causes significant imbalance in rights and obligations of the parties;
- is not reasonably necessary to protect the legitimate business interests of the party who gets an advantage from the term; and
- would cause detriment (financial or otherwise) to the other party if enforced.
We consider five common clauses in franchise agreements that could be an unfair contract term and potential ways to make them fair.
1. Unilateral variation clause
These are terms that permit the franchisor to unilaterally vary the terms of the agreement. These kinds of clauses are not automatically unfair but could cause an imbalance in the parties' rights and obligations.
For example, a term that permits the franchisor to change its fees at any time without notice to the franchisee could be unfair.
This also extends to terms that permit the franchisor to unilaterally vary operations manuals which dictate the procedures and policies a franchisee must comply with, especially if non-compliance with the operations manual is a breach of the franchise agreement.
To make these terms more likely to be considered fair, the terms should:
- specify the circumstances as to when and how the franchisor can adjust their fees;
- provide reasonable notice of the proposed change so the franchisee has time to comply or negotiate; and
- for changes to operations manuals, provide reasonable written notice of the change and a reasonable opportunity for the franchisee to comply, which should be more than seven days.
2. Withholding or setting-off payments
These are terms that permit franchisors to withhold or set-off payments without giving the franchisee corresponding rights. This can cause cash flow issues for small businesses and flow on financial impacts for franchisees, especially when there is a dispute about the amount payable.
Franchisors should consider if the term is reasonably necessary to protect their legitimate interests, and if some limitations should be put in place to preserve the balance between the parties.
A withholding or setting-off payments term should include the following:
- reasonable notice to be provided of the intention to withhold or set-off payments;
- clearly set out circumstances where withholding or setting-off payments is allowed; and
- the method the franchisee could use to dispute or review a decision to withhold or set-off payments.
3. Audit power clauses
These are terms that permit the franchisor to audit the franchisee's business.
These are common and are important for financial transparency between franchisor and franchisee. However, audit power terms are often drafted to include broad discretion for the franchisor to decide when to conduct an audit without giving reasonable prior notice. In some of these clauses, if a discrepancy is identified the franchisee will be required to reimburse the franchisor the amount of the underpayment, and perhaps even the costs of the audit.
These approaches are not considered inherently unfair, however would be more likely to be unfair if there were a requirement to pay interest on an underpayment at a higher default interest rate than normal, and to cover all fees and expenses related to the audit without any limitation.
Clauses allowing the franchisor to conduct an audit of the franchisee should:
- not go beyond what is reasonably necessary to protect the franchisor's legitimate interests; and
- only require the franchisee to pay the proportionate and reasonable costs of the audit.
4. Restraint of trade clauses
These are terms that seek to limit how, when and where a party can supply goods or services after a franchise agreement ends.
These kinds of clauses are not inherently unfair, and often have the purpose of preventing a franchisee from operating a similar business in a certain area, for a certain time, with current or former customers, and soliciting employees to leave the brand.
Features that may make restraint of trade clauses unfair include the length of time, the area, definitions of 'restricted conduct', and the use of 'cascading' clauses which reduce transparency for the franchisee.
To avoid unfairness when including this type of clause, the franchisor should consider what is reasonably necessary to protect their interests in regard to:
- defining the restricted conduct, restraint period and restraint area; and
- ensuring the clauses are consistent with any requirements of the Franchising Code of Conduct.
5. Termination clauses
Unfair termination clauses are those that give one party, usually the franchisor, extensive rights to terminate the agreement without corresponding rights for the franchisee.
The concern with termination clauses is when the franchisor is allowed to terminate the contract based on a much wider range of circumstances than the franchisee, and where the franchisor is allowed to terminate for a breach of any term of a franchise agreement, regardless of whether it was a material or minor breach.
To keep a termination clause fair, it is recommended that the clause:
- does not go beyond what is reasonably necessary to protect the franchisor's legitimate interest;
- is an appropriate remedy for particular but not all breaches of the agreement;
- has balanced termination rights between franchisor and franchisee; and
- allows franchisees a reasonable opportunity to remedy alleged breaches.
Consequences of unfair contract terms
If a term is found to be unfair, it is void so a party can no longer rely on that term.
A court can then:
- void, vary or refuse to enforce the whole or part of a contract to prevent loss or damage caused by the unfair contract terms;
- prevent a term that is the same or substantially similar from being used in any future standard form contract; and
- make an order to restrain a party from applying or relying upon an unfair contract term.
For each unfair contract term in a franchise agreement, the penalty for a corporation is the greater of $50,000,000, three times of the benefit obtained from the conduct or 30% of the company's adjusted turnover during the breach turnover period. For an individual, the penalty is $2,500,000.
Each unfair contract term in an agreement is a separate breach, so penalties can be cumulative.
Does your agreement have any unfair contract terms?
Whether you are a franchisee or a franchisor, it is important to review your current franchise agreement to see if it contains any unfair contract terms.
Our experienced team can review your franchise agreement to ensure they comply with the unfair contract terms legislation or negotiate the terms of your franchise agreement to strike the right balance between franchisor and franchisee. Please contact us if you are concerned about the terms of your franchise agreement.
For further information please contact:
John Trinh, Special Counsel
Phone: + 61 2 9233 5544
Email: jxt@swaab.com.au
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.