Franchise Disputes – Notice of Dispute and the Franchising Code of Conduct

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You have bought into a franchise which you thought was a licence to print money, and suddenly you are in a dispute with the franchisor, the owner of the brand. What can you do? You should issue to the other party a Notice of Dispute under the Franchising Code of Conduct.

When you think about the way franchises are arranged, it’s clear that the franchisor and the franchisee (you) have a lot of common interests. You both want a good volume of trade and a good and growing reputation for the brand. That should swim along nicely in good times, but when things go bad for any reason there are often disputes between franchisor and franchisee.

Common types of franchise dispute where you could use a Notice of Dispute

Some common franchise disputes are over:-

1. Disclosure of required information to a prospective franchisee or false or misleading representations made during negotiations.
2. Refunds of upfront deposits if franchise deals fall through.
3. The franchise territory. What are the exact boundaries? Do you have the exclusive right?
4. The cost of advertising and marketing. Is the franchisor demanding too much money for marketing without any obvious benefit to you?
5. The Operations Manual. Is the franchisor being ridiculously finicky about compliance with the Manual? Or is the franchisor being paranoid and secretive, and not giving you the whole Manual?
6. The supply of brand products. Is the franchisor dictating poor terms for you when you buy the brand products? Are they dictating a supplier which you don’t like? Are they unreasonably dictating the retail price you charge and screwing down your profits?
7. The rights to online sales. Is the franchisor unreasonably restricting your right to trade on the internet?
8. The calculation of royalties payable to the franchisor. You have to pay royalties for the use of the brand of course, but the calculation of what is owing can cause disputes.
9. The termination of the franchise. You may be being terminated by the franchisor for breach of the franchise agreement, by not having strictly complied with updated Operations Manuals. Even if there was a breach of the Operations Manual, is it serious enough to justify termination? Or, what if you have been stuck with a dud franchise and are trying to terminate the franchise? Can the franchisor force you to go on with the business?

The Franchising Code of Conduct

As of January 2015, there was a new Franchising Code of Conduct¹ which cleared the ground for an area of business which is growing dramatically. It recognises that the best way to solve disputes after entering into a franchise agreement is for the franchisor and franchisee to negotiate a truce. Therefore, this legal regime for franchising places a lot of emphasis on mediation between the parties to avoid expensive and lengthy court actions. It also makes the obligations of the parties to the franchise business very clear, and outlines in detail the information which must be given by the parties to each other. It is mandatory and cannot be set aside by contract. A franchise contract can specify its own disputes procedure, but it must be in line with the disputes resolution procedure laid down in the Franchising Code of Conduct.

The Code has a whole section on disputes.² It specifies that the party complaining must give a written notice of dispute which outlines the dispute, the outcome wanted, and what the other party should do to rectify the problem.³ Then the parties should try and resolve the matter, but if they haven’t done so within three weeks, either party can refer the dispute for mediation to an accredited mediator chosen by the parties or by the official Franchising Mediation Adviser.

If after thirty days the mediation has not resolved the dispute, either party can end the mediation. Then you can launch court action over the dispute if it is sufficiently serious. You can launch court action at any time over a franchise agreement and you don’t have to go to mediation first, but mediation is very likely to be much quicker and cheaper. It should definitely be tried first. If you are a franchisee being heavied by the franchisor, mediation will definitely be preferable to going to court.

Obligation to act in good faith & franchise disputes

The Franchising Code of Conduct imposes an obligation to act in good faith on parties to a franchise agreement, and on a prospective franchisee and franchisor even before a contract is entered into.⁴ This statutory obligation overrides any franchise agreement provisions which seek to exclude or limit the obligation.

The obligation to act in good faith applies to:

• a prospective franchisee and franchisor in any pre-contractual negotiation,
• any dealing related to the proposed franchise agreement,
• anything related to the performance of the contract itself,
• any dispute resolution, and
• any dispute related to termination of the agreement.

Therefore, each party must act in good faith in resolving a dispute notified under a Franchising Notice of Dispute.

The obligation of good faith does not prevent a party from acting in its own legitimate commercial interests. However, when a court decides if a party has breached the obligation to act in good faith, the court may have regard as to whether the party acted honestly and not arbitrarily and whether the party cooperated to achieve the purposes of the agreement.

A recent finding against a huge franchisor shows that the Courts will vigorously apply the ‘good faith’ provisions of the Franchising Code of Conduct

In 2019, the case was decided by the Federal Court of a prospective UltraTune franchisee⁵ who was, amongst other breaches, lied to about the existing franchise he was looking to acquire and who was refused the return of a $33,000 deposit he had paid before signing the franchise. The Court found UltraTune to be in significant breach of the Franchising Code of Conduct because –

• During negotiations false representations were made regarding the history, rent, other costs, and business position of the franchise outlet.
• UltraTune did not provide the prospective franchisee with the disclosure documents which the Code requires before he paid a $33,000 deposit for training and other upfront costs.
• When the deal fell through, before it was signed or training commenced, UltraTune refused to return the deposit, which breached the Code because UltraTune had not yet complied with its Code obligations and could not yet receive a non-refundable deposit.
• UltraTune provided confusing and misleading information about its compulsory marketing and advertising fund and how it was used.
• UltraTune lacked a ‘culture of compliance’ with the Code and was systemically negligent regarding compliance.

The culture finding made it clear that the Courts would look carefully at breaches to determine if they were inadvertently negligent or they reflected a generally bad attitude of the franchisor. The finding also makes it clear that the Courts would apply the Code just as strictly if the franchise deal has not yet been signed.

Just to ensure that its judgement was noticed by the whole franchising sector, the Court fined UltraTune $2.6m, reduced on appeal to $2m, and ordered them to pay the ACCC’s legal costs.

Legal advice will be essential if you are in a dispute with your franchisor. Even if you don’t end up in mediation or court, it is a good idea to get a legal perspective on the whole mess before you take up arms.

References:

1. Franchising Code of Conduct, Schedule 1 of the Competition and Consumer (Industry Codes – Franchising) Regulation (Cth) 2014;
2. Part 4 of the Franchising Code of Conduct;
3. Franchise dispute notification under sections 38 and 40 of the Franchising Code of Conduct;
4. Section 6 of the Franchising Code of Conduct;
5. Australian Competition & Consumer Commission v Ultratune Australia Pty Ltd [2019] FCA 12, 18 January 2019.

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