Every year, franchisors across Australia update their franchise disclosure documents.
Or at least, they think they do.
Many approach the process with admirable optimism. Open last year’s version. Change a few dates. Refresh a few figures. Save as PDF. Job done.
Unfortunately, that approach is responsible for many of the disclosure issues we encounter in practice.
The annual disclosure document update is one of the most misunderstood compliance obligations under the Franchising Code. Whilst most franchisors understand an update is required, many underestimate the extent of the review that should occur before the updated document is issued.
As franchise lawyers, we regularly review disclosure documents for both franchisors and prospective franchisees. The same issues appear again and again. Most are entirely avoidable. Some can expose a franchisor to ACCC scrutiny, franchisee disputes or allegations of misleading conduct.
So where do franchisors most often come unstuck?
First, a Reminder: The Update Is Mandatory
Under section 21 of the Franchising Code, a franchisor that is party to a franchise agreement and either entered into multiple franchise agreements in the previous financial year, or intends to enter into further franchise agreements in the current financial year, must update its disclosure document within four months after the start of its financial year.
The updated disclosure document must reflect:
- the position of the franchise system and franchisor as at the date of the update; and
- any amendments to the Franchising Code since the document was last updated.
Importantly, the disclosure document must also remain in the prescribed format set out in Schedule 1 of the Code. The headings, numbering and structure matter. This is not a document where franchisors are free to get creative.
Failure to comply attracts penalties of up to 600 penalty units.
Mistake #1 – Not Understanding Earnings Information
This is probably the biggest issue we see.
Many franchisors think earnings information means a formal financial forecast.
It doesn’t.
The definition is much broader than that.
It can include historical earnings data, projected earnings, assumptions and, importantly, any information from which future earnings may be assessed.
The trap is that many franchisors treat earnings information as a system-wide issue.
The Code does not.
Earnings information should be considered on a grant-by-grant basis.
A representation that may be entirely appropriate for a flagship metropolitan location may be wholly inappropriate for a regional territory. Likewise, earnings information provided verbally, in recruitment material or during discovery days can create disclosure obligations that franchisors never intended to trigger.
If there is one area of the disclosure document where franchisors should proceed cautiously, this is it.
A disclosure issue can very quickly become a misleading conduct issue.
Mistake #2 – Item 14 Is Three Years Out of Date
Item 14 deals with establishment costs.
It is also one of the most commonly neglected sections of the disclosure document.
Every year we see franchisors recycling establishment cost estimates without asking a simple question:
“Could a franchisee actually establish the business today for these figures?”
Fitout costs increase.
Equipment costs increase.
Software costs increase.
Professional fees increase.
Construction costs increase.
Interest rates change.
Labour costs change.
Yet somehow many Item 14 estimates remain exactly the same year after year.
That’s a problem.
Prospective franchisees are entitled to rely upon those figures when assessing the capital required to enter the system. If the figures no longer reflect reality, the disclosure document is no longer doing its job.
A prudent franchisor should be benchmarking Item 14 annually and treating it as a live commercial document, not a historical artefact.
Mistake #3 – Getting the Financial Disclosure Wrong
Item 21 remains one of the most technical parts of the disclosure document.
It is also one of the most misunderstood.
Many franchisors know they need to attach financial information. Fewer understand precisely what financial information is required.
The Code provides several alternative pathways depending on the circumstances of the franchisor.
In some cases, financial reports for the previous two financial years are required.
In other cases, a solvency statement supported by an independent audit may be sufficient.
Special rules apply to newer franchisors. Different rules can apply where the franchisor forms part of a consolidated group.
One particularly common mistake is confusing a director’s solvency declaration with a statutory declaration.
They are not the same thing.
The starting point is the solvency statement required under Item 21(1). This is a statement signed by at least one director confirming that there are reasonable grounds to believe the franchisor can pay its debts as and when they fall due.
A statutory declaration, however, is a separate document required in specific circumstances, including where the franchisor has not existed for the requisite period or where insolvency issues have arisen during the relevant reporting period.
Unfortunately, we regularly see:
- missing solvency statements;
- missing statutory declarations;
- outdated financial reports;
- financial reports for the wrong entity;
- incomplete audit material; and
- disclosure documents following the wrong Item 21 pathway altogether.
This is one area where “close enough” simply isn’t good enough.
Mistake #4 – Confusing Renewal and Extension
These words are not interchangeable.
The Franchising Code treats them differently.
A renewal generally involves entering into a new franchise agreement.
An extension generally involves extending the term of the existing agreement.
The distinction matters because Item 18 requires franchisors to disclose:
- renewal rights;
- extension rights;
- goodwill entitlements;
- end-of-term arrangements;
- significant capital expenditure considerations; and
- restraint of trade provisions.
The Code also requires prescribed warnings in certain circumstances.
Yet many disclosure documents continue to use the concepts interchangeably.
If your franchise agreement distinguishes between renewal and extension, your disclosure document should too.
Mistake #5 – The Disclosure Document Doesn’t Match the Franchise Agreement
This is the easiest mistake to avoid.
It is also surprisingly common.
The disclosure document and franchise agreement serve different purposes, but they should tell the same story.
If the franchise agreement allows the franchisor to charge management fees, those fees should appear in the disclosure document.
If the franchisee is required to purchase stock from the franchisor, that should be disclosed.
If supplier restrictions exist, they should be disclosed.
If lease arrangements exist, they should be disclosed.
The disclosure document is a point-in-time document, but it must accurately reflect the franchise agreement.
Every annual update should involve a thorough cross-check between the two.
Mistake #6 – Taking Too Narrow a View of Rebates
Many franchisors understand they must disclose supplier rebates.
Far fewer understand how broadly the Code approaches the concept.
The disclosure obligation extends to rebates and other financial benefits.
That phrase should be given a broad interpretation.
In practice, it may capture:
- referral fees;
- commissions;
- software referral arrangements;
- equipment referral payments;
- marketing incentives;
- volume bonuses;
- network incentive arrangements; and
- benefits received through related entities.
One increasingly common example is referral payments made to existing franchisees for introducing prospective franchisees to the network.
Many franchisors don’t immediately think of these arrangements as rebates.
The ACCC may take a different view.
Importantly, disclosure is not limited to identifying that a benefit exists. The Code may require disclosure of:
- who pays the benefit;
- the nature of the benefit;
- the percentage received; and
- whether any part of the benefit is shared with franchisees.
If money is flowing into the network from suppliers, service providers or referral partners, it is worth asking whether Item 10 requires further consideration.
The Disclosure Document Is Not a Template
Perhaps the biggest mistake of all is treating the disclosure document as a precedent.
It isn’t.
The disclosure document is a living compliance document.
Every year it should be reviewed against:
- the current franchise agreement;
- recruitment practices;
- earnings representations;
- supplier arrangements;
- rebates and incentives;
- establishment costs;
- financial disclosure requirements; and
- changes to the Franchising Code.
Simply rolling forward last year’s version is one of the fastest ways to create compliance problems.
Can Franchisors Do This Themselves?
Absolutely.
Many do.
The Franchising Code does not require a franchisor to engage a franchise lawyer to prepare or update its disclosure document, and many smaller networks elect to undertake the annual update process internally.
That said, the disclosure document has become increasingly complex over the years. The Franchise Disclosure Register, expanded disclosure obligations and increasing ACCC scrutiny mean that what appears to be a straightforward annual update often involves a surprising number of judgment calls.
In our experience, most disclosure document issues do not arise because a franchisor intentionally withholds information. They arise because the franchisor does not realise a particular disclosure obligation has been triggered, or because last year’s document is simply rolled forward without adequate review.
We love helping franchisors through this process and regularly assist with annual disclosure document reviews, disclosure updates and broader franchise compliance audits.
Sometimes that involves a complete refresh.
Sometimes it is simply a second set of eyes before the document is issued.
Either way, a review is invariably cheaper than explaining a disclosure issue to the ACCC or defending a dispute brought by a disgruntled franchisee.
Final Thoughts
The best disclosure documents are not the longest.
They are not the most complicated.
They are the ones that accurately reflect the franchise system being offered today.
For franchisors, the annual update should be viewed as a compliance health check, not a box-ticking exercise.
For franchise lawyers, franchise consultants and franchisor advisers, the annual update remains one of the best opportunities each year to identify and rectify issues before they become disputes.
Because when a franchise relationship goes wrong, one of the first documents everyone reaches for is the disclosure document.
And when that happens, you want to be confident it was updated properly