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Focus: Changes to unconscionable conduct laws and Franchising Code of Conduct

5 March 2010

In brief: The Federal Government has released the report of the expert panel appointed to examine proposals for regulation of the unconscionable conduct provisions in the Trade Practices Act 1974 (Cth), and agreed to clarify the provisions, and consider amending the Franchising Code of Conduct to require greater disclosure about franchise agreements and their risks. Partners Carolyn Oddie (view CV) and Tim Golder (view CV) and Senior Associates Robyn Chatwood and Alexander Gelis report.

How does it affect you?

  • The Government has agreed to amend the unconscionable conduct provisions of the Trade Practices Act 1974 (Cth) (the TPA) and the Franchising Code of Conduct.
  • Once the Australian Consumer Law comes into effect, businesses may be liable for civil pecuniary penalties of up to $1.1 million for contravention of the statutory unconscionable conduct provisions.
  • Businesses will need to consider the impact of any changes to the unconscionable conduct provisions, particularly the fact that it is recommended there be no requirement to identify a special disadvantage for the provisions to apply.
  • Franchisors may need to prepare another short form disclosure document and give this to franchisees with the existing lengthy disclosure document. The Government will consider amending the Franchising Code to mandate the recommended additional disclosures if evidence emerges of a systemic failure by the franchising industry to provide these new disclosures on a voluntary basis.
  • All businesses, but particularly franchisors and businesses in positions of bargaining strength, will need to review their conduct once legislation is introduced to Parliament, to ensure that they comply with any amended unconscionable conduct laws.

Background to the Report

As reported in our Client Update, the Minister for Innovation, Industry, Science and Research, Dr Craig Emerson, has foreshadowed changes to the Franchising Code of Conduct (the Franchising Code). At that time, Dr Emerson also established a three-member expert panel to advise him on two further issues:

  • whether the unconscionability provisions of the TPA should be changed; and
  • whether the Franchising Code should include examples of specific behaviours that would be considered inappropriate in a franchising arrangement.

Further, the Government specifically requested that the Panel examine particular behaviour (described as the 'five behaviours') in the franchising industry:

  • franchisors' unilateral rights to vary franchise contracts;
  • franchisees' obligations to make unforeseen capital expenditures;
  • franchisors' amendments to franchise contracts when franchisees are seeking to sell their franchises;
  • terms obliging franchisees to pay franchisor's legal costs; and
  • confidentiality obligations on franchisees that have the effect of restricting information provided to new or prospective franchisees.

The Government has released the Panel's Report,1 together with the Minister's response to it, and, in short, agrees with the Panel's practical approach to the issues. The Report and Response will, in large part, be welcomed by franchisors.

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Unconscionable conduct – the Report' s key recommendations

The Panel commented on the lack of understanding of the statutory unconscionable conduct provisions, which contribute to a lack of certainty about, and confidence in, their application.

Interpretive principles to be included

The Panel recommended that a statement of principles be included in the TPA as an aid to interpretation and that these principles be closely aligned to the way the law is being settled. Recommendations include:

  • confirmation that the statute extends the common law and equitable doctrines – while noting that the provisions are not designed to catch conduct that was merely 'unfair';
  • courts may examine the terms and progress of a contract – confirming that issues associated with the behaviour of the parties in relation to the contract are relevant;
  • systemic conduct or patterns of behaviour can be caught – so sales methods, as well as particular arrangements, may be examined; and
  • identification of a special disadvantage is not necessary – what will be examined is whether a party has done 'what should not be done in good conscience' or acted in a manner attracting 'a high degree of moral obloquy'.2 Confirmation that no special disadvantage is required will, arguably, strengthen the usefulness of the provisions for small business.
Guidance and test cases recommended

While the inclusion of a statement of principles was previously recommended by a Senate Economics Committee, the Panel rejected another of the Committee's recommendations: to include specific examples of unconscionable conduct in the TPA. The Panel's view was that there were no clear examples that could be agreed upon because conduct that was unconscionable in one circumstance may not be in another. However, the Panel noted that there were sufficient useful examples being 'continually generated' 3 through the enforcement activities of regulators and as a result of private litigation.

Consistent with this, the Panel recommended that the Australian Competition and Consumer Commission, the Australian Securities and Investment Commission and state regulatory authorities take action to:

  • produce uniform guidance on the unconscionable conduct provisions; and
  • pursue test cases to enable greater community understanding of the laws.
Unification or harmonisation of sections 51AB and 51AC

The Panel expressed concern there was the possibility of the meaning of unconscionable conduct being different under s51AB (which governs unconscionable conduct in relation to consumers) and s51AC (which governs unconscionable conduct in relation to business-to-business relationships). The Panel recommended that the two provisions be unified or harmonised.

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Franchising Code of Conduct – the Report's key recommendations

Additional disclosure

The Panel recommended a short, simple 'plain English' disclosure document voluntarily be provided by franchisors in addition to the existing lengthy disclosure document, to act as a 'ready reference to the nature of the franchise relationship'.

That additional document would be designed to highlight items (including unilateral contract variation or operations manual variation clauses) that a prospective franchisee would need to consider before agreeing to the contract. The Panel noted that the additional document should require disclosure of:

  • 'key costs, benefits and risks of the franchise system';
  • the statement that 'franchising is a business and that like any business the franchise (or franchisor) could fail during the franchise term'; and
  • disclosure of unforeseen capital expenditure and unilateral contract variation through the operations manual.

The Panel did not make clear when the additional disclosure document is to be provided but said that it should be 'earlier in the process of entering a franchise agreement'.

Most franchisors in the industry will see this additional disclosure as an extra administrative burden and worry about the ramifications of an inaccurate disclosure, given that the voluntary disclosure will constitute representations by the franchisor to the franchisee, inducing the entry by the franchisee into the franchise agreement.

Disclosure of franchisee payments to third parties

The Panel rejected prohibiting franchisors from requiring expenditures by their franchisees without the franchisees' consent. Instead, the Panel opted to recommend an amendment to the item 13.6 disclosure requirement so as to mandate that information is provided to the franchisee on any payments that it will need to make to third parties.

The Minister's response did not comment directly on the recommendation to amend item 13.6 and so the Government's position in relation to that issue remains unclear.

Disclosure of confidentiality obligations

In reviewing the topic of confidentiality clauses in franchise agreements, the Panel focused on their effect to restrict franchisees from discussing either the franchise or other important matters relating to the franchise system with other, or prospective, franchisees. Such restrictions could be seen to diminish the value of the mechanisms in the Code designed to protect freedom of association of franchisees (clause 15 of the Code).

The Panel recommended that franchisors provide greater disclosure of the existence and effect of any confidentiality restrictions in the franchise agreement. The Minister's response did not comment directly on this recommendation.

Applying the transfer provisions in the Code to novations

The Panel recommended amendments to the Code to cater for novation of the franchise agreement in addition to transfers of it. It should be noted that, generally, prudent franchisors presently adopt the approach that the provisions in the Code dealing with transfers of the agreement apply also to novations.

The Panel recommended that the Government consider circumstances in which it is always unreasonable to withhold consent to a transfer of a franchise agreement (clause 20(2) of the Code presently prohibits a franchisor from unreasonably withholding its consent to a transfer).

The Minister's response did not comment directly on this recommendation.

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What next?

The Government's changes will largely be welcomed by businesses, particularly those involved in franchises, and those in customer or supplier relationships with unequal bargaining positions. Until draft legislation is released, however, there will be a degree of uncertainty for many businesses.

For further information, please contact any of the people below.

Footnotes
  1. Expert Panel (Professor Bryan Horrigan, Mr David Lieberman, Mr Ray Steinwall), Parliament of Australia, Strengthening statutory unconscionable conduct and the Franchising Code of Conduct, Canberra, February 2010.
  2. Expert Panel, p.34.
  3. Expert Panel, p.28.

For further information, please contact:

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