In the past, franchisors have been able to on-charge any and all legal costs incurred during the term of franchise agreements to their franchisees. However, recent landmark changes to the Franchising Code of Conduct (the Code), which become operative from 1 July 2021, are set to change how franchisor legal costs are dealt with. In particular, one provision of the new Code is causing great concern amongst franchisors, likely because it could come at a significant cost by way of increased legal bills.
As a franchisor, you should be aware of these changes so you can prepare accordingly. This includes undertaking a review of your cost and fee structures and ensuring your practices are not in breach of the new Code. This article will explain the relevant changes to the Code and what they mean for franchisors.
What is the Current Law?
It is commonplace for franchisors to pass on legal costs to their franchisees during their franchise agreement term. Frequently, an invoice for legal fees will accompany, for example:
- breach notices;
- termination notices;
- renewal documents; and
- deeds of various kinds.
These invoices, representing the legal costs payable by the franchisor for preparation of the relevant document, often do not come cheap.
Most standard franchise agreements contain an all-encompassing clause entitling the franchisor to recover any and all legal costs incurred in connection with the specific franchise agreement from the franchisee. The clause does not specify or quantify what those costs are.
In essence, contractual provisions of this nature acted to protect franchisors from being liable for legal fees as a result of the franchisee's action or inaction. This means that franchisors were not out of pocket in the event of, for example:
- a franchisee's breach, termination or renewal; or
- the sale of a franchise business.
However, once the changes to the Code take effect from 1 July, oncharging legal costs will be prohibited, so franchisors will be banned from recovering any or all legal costs incurred in connection with the specific franchise agreement, provided those costs are incurred after the franchise business in question commences operations.
The New Code and Charging Franchisees for Legal Fees
The amending regulations provide, at 19A(1), that a franchisor must not enter into a franchise agreement that requires the franchisee to pay all or part of the franchisor's costs of legal services for documents ‘relating to the agreement'. The term ‘relating to' appears to be intentionally broad and intends to capture all:
- breach notices;
- termination notices;
- renewal documents; and
- similar.
When interpreting statutory provisions, you should give words their ordinary, everyday meaning. The term ‘relating to', in everyday language, is a broad term, and you should apply it accordingly.
Section 10A(2) lists the sole exception to this blanket rule, being payment of:
(a) a fixed amount;
(b) which is specified in the agreement; and
(c) to be paid before the franchisee starts the franchised business; and
(d) is for the franchisor's costs of preparing, negotiating or executing the franchise agreement (i.e. what is typically referred to as the documentation fee).
The interpretation of this provision is consistent with the explanatory memorandum that accompanies the regulations. It provides that the purpose of this amendment is to address concerns regarding franchise agreements that contain clauses exposing franchisees to future legal costs. These costs are, at the time of entering into the franchise agreement, unquantifiable.
What About Renewal?
Given a renewal occurs after a franchisee has started the franchise business, it appears that you, as a franchisor, can no longer charge for the preparation of the franchise agreement to be entered into at renewal. Taking this one step further, a franchisor will not be able to charge for lease negotiations or associated costs if the lease is re-negotiated for any reason after the franchised business has commenced. Given costs associated with retail lease reviews and negotiations can be significant, this could and likely will represent a hefty expense for retail and premises-based franchise systems.
What Can I Do to Recoup the Costs?
Legal services cost money. It seems unfair that you as the franchisor will be out of pocket if, for example, a franchisee continually breaches the agreement, leaving you with the bill arising from formally documenting those breaches. However, there are some solutions that you can implement.
Tweak the Fee Model
It may be the case that franchisors introduce some new fees to be triggered by events. For example, a ‘breach fee' or ‘termination fee'. If you are considering this, it is important that you draft any such fees carefully. Otherwise, you could attract the provision of the new Code described in this article.
Further, you should ensure that the fees cannot be characterised legally as a penalty, in which case the relevant clauses could be deemed unenforceable. To avoid being characterised as a penalty, the fee sum must represent a genuine pre-estimate of loss (i.e. what the breach will actually cost the franchisor).
Additionally, you will need to keep in mind good faith and unfair contract obligations.
Key Takeaways
The new amendments to the Franchising Code of Conduct will become operative from 1 July 2021. They are causing concern for many franchisors. This is because one key amendment will prevent franchise agreements from containing clauses that expose franchisees to future legal costs which are unquantifiable at the time of entry into the agreement. This means that franchisors might be stuck with higher costs for legal services, particularly those with large networks.
However, you can improve this by tweaking your fee model. Another great option is to join the LVConnect Pro franchisor subscription. Here, you can obtain legal services for a set monthly fee. If you would like more information about changes to the Code or LVConnect Pro, contact Legalvision's franchise lawyers on 1800 534 315 or fill out the form on this page.
