Insights / May 16th, 2023

Environmental Social Governance (ESG) in Franchising – How ESG obligations can be contractually enforced in franchising contracts.

With more and more businesses implementing ESG strategies, obligations tied to these ESG strategies are being passed down contractually to suppliers, subsidiaries, franchisees, and other key businesses within value chains to ensure broader compliance with the ESG strategy. Accordingly, franchisees need to be aware of their obligations and how these obligations fit within the broader ESG strategy of the relevant franchise.

What is ESG?

ESG stands for Environment, Social and Governance. It looks at the broader risks pertaining to a business from an environmental, social and governance perspective. ESG takes a holistic view and looks at the long-term value of an organisation beyond the immediate decision makers with various stakeholders in mind, including the community, shareholders, consumers, and the environment.

ESG is relevant to every business, but individual ESG strategies will differ depending on the ESG factors that apply to the relevant business. An ESG strategy is a business plan for incorporating ESG factors into business operations with a view of creating long-term value. For example, a large emitter such as a coal mine may have mandatory greenhouse gas emissions reporting requirements under the National Greenhouse and Energy Reporting Scheme which will fall within their “E” strategy, whereas another business will instead include their voluntary, net zero transition plan within their “E” strategy.

Contractual enforcement of ESG factors

An ESG strategy can have, and may be legally required to have, application to entities which are connected to the organisation who created the ESG strategy. For example, we are seeing ESG clauses being added to contracts to bind:

  • suppliers;

  • subsidiaries (and other connected entities within a corporate group); and

  • franchisees,

to ESG factors set by the relevant entity. This is necessary to ensure that there is a consistent brand experience and value alignment across all entities within an organisation’s value chain. 

In relation to franchisees, there may be contractual clauses that oblige franchisees to do the following:

  • For the “E”: mandatory use of renewable energy sources, broader sustainability practices such as waste management and water usage, measuring greenhouse gas emissions.

  • For the “S”: reporting requirements to comply with the franchisor’s reporting obligations under the Modern Slavery Act 2018 (Cth) (Act), the use of an “approved supplier list” for further compliance under the Act, adoption of policies such as whistleblower policies and anti-discrimination policies.

  • For the “G”: adoption of policies such as anti-bribery and corruption policies, diversity reporting and broader business reporting obligations for risk mitigation and management.

Good faith and ESG clauses

Underpinning compliance for franchisees and franchisors is the Franchising Code of Conduct (the Code). The Code imposes obligations on the parties to a franchise agreement to act in good faith. The courts have interpreted this to mean, for example, that franchisors and franchisees must act:

Accordingly, in relation to ESG clauses, franchisors should ensure that:

1.             in both the pre-contractual and contractual stages, that they have provided the franchisee with adequate information about their ESG strategy (i.e., policy and procedure documents, copies of their ESG strategies and any public reports made (e.g., Sustainability Reports); and

2.             they have adequately explained (and given adequate notice about) the obligations that will be imposed on the franchisee for the duration of the franchising agreement (in particular, onerous reporting requirements).

For franchisees, the good faith obligation, in conjunction with an ESG clause, imposes obligations to co-operate with their franchisors and to act reasonably in fulfilling obligations imposed on them relating to the “E”, “S” and “G” pillars of their franchisor’s ESG strategy. Franchisees have a unique role to play in the promotion of ESG values within a franchise and in the fulfilment of the franchise’s ESG strategy. By adopting a strong ESG strategy which is complied with across the brand, franchise systems can enhance brand reputation, attract investment, improve risk management, and improve operational efficiency.

ESG strategies are now the “norm” for businesses and the compliance requirements will continue to flow down through supply chains, value chains and franchise systems. Franchisees should expect to see ESG clauses implemented into their franchise agreements and should take steps to understand what this practically means for them and their business. For franchisors, in developing an ESG strategy, the method of flowing these obligations down to franchisees should be considered so that franchisees have the resources and knowledge for compliance and are given sufficient notice to do so. 

Our ESG and Franchising Teams are well equipped to assist franchisors and franchisees with developing ESG strategies and to provide advice on how to comply with ESG contractual requirements. For further information, please reach out to our ESG or Franchising Teams.

This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice.  You should not act upon the information contained in this publication without obtaining specific professional legal advice.  No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.