Insights / May 1st, 2023

The good faith obligation: compliance at the pre-contract stage

In our last insights, we explained what is meant by the obligation to act in good faith under the Franchising Code of Conduct (Code).

Under the Code, a party who is found to breach the obligation to act in good faith can face penalties of up to $165,000. Franchisors are also at risk of suffering reputational damage which can potentially cause business losses which by far exceed this amount.

So what steps can franchisors in particular take in order to ensure compliance with the obligation to act in good faith in their dealings with existing and prospective franchisees?

It is important firstly to remember that the good faith obligation applies to all parties to a franchise agreement, as well as those who propose to become a party. In this series of insights, we will look at some of the practical ways that franchisors can try to ensure they comply with the good faith obligation at each of the following stages:

  • pre-contract dealings, negotiations or disputes (Part 1);

  • the term of the franchise agreement (Part 2); and

  • any matters or disputes relating to the agreement which arise after termination (Part 3).

Compliance at the pre-contract stage

Even before the pre-contract stage, franchisors should first look carefully at what their contracts say!

Because the Code prohibits franchisors from entering into an agreement that contains terms which purport to contract out of or attempt to limit the good faith obligation, franchisors should therefore review their agreements in order to ensure that they don’t include any such terms.

However - be aware also that a clause could be troublesome if it has this effect, even if the wording doesn’t specifically refer to the good faith obligation. Contract review should therefore focus not only on the wording but how the clause would operate and whether the potential consequences could be considered to be in bad faith.

Given the strict obligations under the Code for pre-contract disclosure, franchisors should also carefully consider their processes and procedures to ensure that in pre-contract dealings:

  1. all prospective franchisees are given a copy of the information sheet as soon as possible, no later than 7 days after receiving the inquiry and before the contract documents;

  2. all existing and prospective franchisees receive a copy of the Code, a complete and correct Disclosure Document, Key Facts Sheet and franchise agreement as early as possible (and no less than 14 days before entering into the agreement);

  3. representatives of the franchisor understand their obligations under the Code and in dealings with prospective franchisees do not make representations that are untrue or misleading. This could also possibly include staying silent if the franchisee indicates that they have an incorrect understanding about something to do with the franchise;

  4. all relevant information about the franchise is clearly and correctly stated in the disclosure document and any other materials, including details of the history of the franchise site, all fees and charges payable and any beneficial interests of the franchisor; and

  5. where the franchisee has signed a lease or agreement with the franchisor or its associate, then a copy of that document is provided to them within 1 month after signing, together with details of any incentive or interest received by the franchisor.

We hope this insights provides some useful guidance about how to comply with the good faith obligation at the pre-contract stage. Stay tuned for part 2, where we will look at practical tips for staying compliant with the obligation during the term of the franchise agreement.

For further information, please get in touch with our Franchising team.

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.

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