Franchise agreements are legally binding documents that govern the business relationship between franchisors and their franchisees.  The importance to franchisors of ensuring that these documents are appropriately prepared, executed and are enforceable cannot be overstated, write Alicia Hill and Andrea Hetherington at McInnes Wilson Lawyers.

Once a lawyer has prepared a template set of franchise documents and the franchisor has signed up their first franchisees, a franchisor may issue their own franchise documents to save franchisees extra costs.

While there is certainly something to be said for cost saving, there are a number of traps which franchisors can fall into.

Here are some common pitfalls and the associated risks:

1. Disclosure of relevant information

The disclosure document must comply with the Franchising Code of Conduct: it must be laid out in the prescribed format and contain all the required information. Disclosure documents must be updated by a franchisor at the conclusion of each financial year by 31 October at the latest. 

Disclosure obligations to franchisees not only include the content of the disclosure document itself, but also items such as associated leases or licenses to occupy and benefits or incentives the franchisor may receive from a landlord or associated party. 

Any facts of material consequence such as changes to the franchisor’s financial position, ownership, certain legal proceedings or judgements and changes to the intellectual property of the franchise must also be disclosed to all franchisees. 

A franchisor may easily overlook a number of these issues altogether or fail to comply with the disclosure time frames. 

Failure to give correct disclosure to a franchisee exposes the franchisor to financial penalties of up to $54,000.  And if an issue is systemic, this could significantly increase the franchisor’s financial exposure.

2. Incorrect parties or improper execution

Franchisors need to get the party details correct in the franchise agreement. 

For example, if a franchisee is a company or a trust, the full and correct details must be included in the documentation and all the correct individuals must sign the agreement.

If the franchisee will be more than one individual, such as a husband and wife partnership, then each individual’s name must be cited as a franchisee if the agreement is to be enforceable against each of them. 

Some franchise agreements also contain multiple places for execution, such as guarantor sections, and ancillary documents in schedules that must also be signed, for example restraint of trade agreements. 

If these are not initially checked for proper execution, the first time a missing signature or some other issue may be identified is after a dispute has arisen – when it is probably too late to correct it.   

A franchise agreement incorrectly executed has the potential to fatally compromise the franchisor’s ability to enforce the agreement. 

3. Failure to take security

If a franchisee is a company or trust set up specifically to operate a franchised business, there is still a need to obtain a personal guarantee from the owners or directors. Even if franchisors do this they may not check that a personal guarantee has been executed in a manner that will render it enforceable later on. 

Another significant issue is the failure to remember to register (or register properly) a general security interest over the franchisee on the Personal Property Securities Register, if the franchise agreement provides for this.  In the event of franchisee insolvency the franchisor’s security would then be worthless if unregistered.

4. Record keeping

The Code requires the disclosure document to be given to an existing or prospective franchisee at least 14 days before entering into a new franchise agreement. 

Franchisors should always keep a written record of when a disclosure document was issued to a franchisee; failure to do so exposes the franchisor to risk of a dispute over compliance. 

The Code further prohibits a franchisor from entering into a franchise agreement (or renewing, transferring or extending an existing agreement) unless the franchisee has provided a written statement that they have received, read and had a reasonable opportunity to understand the disclosure document and the Code. 

This statement is typically known as a “section 10 certificate” and is often provided to franchisees either as a separate document or as a schedule to the franchise agreement itself. A franchisor who fails to get this from a franchisee before they sign the agreement will be in breach of the Code. 

5. Failing to update agreement terms after changes in the law

It is important to ensure that franchise agreements are kept up to date with changes to other laws such as the Privacy Act 1988, the Personal Property Securities Act 2009, and the Business Names Registration Act 2011. 

Law firms have a professional responsibility to ensure that franchise documents issued by them are up to date and in line with all current laws relating to franchising. By engaging a law firm to prepare and issue franchise documents on their behalf, franchisors can be reassured that any changes in the law that are relevant to their documents will be brought to their attention.

The process of issuing and signing franchise documents is not a purely administrative task and requires at least some understanding of legal issues to ensure that the documents will be properly prepared and enforceable.  The consequences of failing to get it right can range from fines issued by the ACCC, to unenforceable franchise agreements. 

Franchisors should carefully consider these risks when making a decision to start issuing franchise documents in house.  Sometimes an upfront outlay in legal fees can save significant loss down the track.

Alicia Hill (left) is a principal of McInnes Wilson Lawyers with experience in commercial dispute resolution and compliance and a member of the ACCC’s Consultative Committee for Small Business and Franchising.

Andrea Hetherington (right) is a solicitor of McInnes Wilson Lawyers with experience in franchising, licensing and commercial laws.