What is significant capital expenditure?
The Franchising Code of Conduct does not provide a specific definition; however, some key examples of significant capital expenditure include equipment upgrades, renovations of premises or upgrades to fit-outs. Franchise Agreements often give franchisors the right to require franchisees to undertake these works in order to ensure the franchised business meets the uniform standards required by the Franchisor.
So what has changed in the Franchising Code of Conduct?
Even before the changes to the Code, franchisors were prohibited from requiring franchisees to undertake significant capital expenditure during the term, except in the circumstances described in the Code (and set out below):
- Expenditure disclosed in the disclosure document
- Expenditure incurred by all or majority franchisees following a vote
- Expenditure incurred by the franchisee to comply with legislative obligations
- Expenditure agreed by the franchisee; and
- Expenditure that franchisors considered as a necessary capital investment in the franchised business, justified by a written statement given to the franchisee.
Following the changes to the Code, the final exception above has been removed. As a result, franchisors can no longer enforce an obligation to undertake significant capital expenditure unless it’s agreed to by the franchisee (or a majority of franchisees if the expenditure is required across the network), is required in order to comply with legislative obligations, or is disclosed in the disclosure document.
This change makes it all the more important that any significant capital expenditure required of franchisees is disclosed in the disclosure document.
In addition, franchisors now have greater disclosure requirements in relation to significant capital expenditure. To rely on the disclosure document exception, franchisors are required to provide all of the following additional information:
- The rationale for the expenditure
- The amount, timing and nature of the expenditure
- The anticipated outcomes and benefits of the expenditure
- The expected risks associated with the expenditure.
For experienced franchisors, these points may sound familiar. This is the same information franchisors were required to provide to justify the requirement for significant capital expenditure using the old exception.
Is disclosing details of the capital expenditure enough to fulfill my franchisor obligations?
Short and sharp, the answer is no. In addition to disclosure in the disclosure document, franchisors must ensure that before entering into the agreement, they have a formal discussion with the franchisee about the expenditure. This discussion must address the circumstances under which the franchisee considers whether it is likely to recoup the expenditure, having regard to the geographical area of operations of the franchisee.
We recommend making this a formal step in your onboarding process and keeping detailed records of each meeting to reduce the risk of a dispute arising about these conversations down the track
- Franchisors can no longer require franchisees to undertake significant capital expenditure because they deem it as necessary capital investment unless it meets one of the other exceptions including having been disclosed in the disclosure document and in discussions with the prospective franchisee;
- The other pre-existing exceptions still apply;
- Franchisors need to update disclosure document to account for additional disclosure requirements;
- Franchisors need to have a conversation with the franchisee before entering the agreement and keep a record of those conversations.
This is just one aspect of the changes to the Franchising Code of Conduct. If you are yet to update your franchise documents, get in touch with our experienced franchise lawyers here at BlueRock.