Commercial Law Brisbane: September 2018

Thursday, September 20, 2018

Is Your Franchise Agreement Unfair?

Australia has numerous industry codes and laws governing franchising. Industry codes are sets of enforceable rules and measures regulating the conduct of that industry. Franchising is regulated by the Franchising Code of Conduct (Code), together with the Australian Consumer Law (ACL).

The Australian Competition and Consumer Commission (ACCC) is the nation’s competition and consumer watchdog. A compliance and enforcement priority of the ACCC for 2018 is the protection of small businesses in relation to unfair terms in business contracts. Franchisor-compliance with the Code and the ACL is on the forefront of the ACCC’s radar.

With this ACCC focus, it is important that franchisors review and audit their standard template franchise agreements to ensure full compliance, if they have not already done so. Of particular note is the business-to-business unfair contract terms regime under the ACL.

Franchisors should remember that the ACCC can require franchisors to provide to the ACCC documents which the franchisor is obligated to generate or keep under the Code, which include franchise agreements and disclosure documents.

The Unfair Contract Terms Regime and Franchise Agreements

Generally, franchise agreements are likely to be caught by the unfair contract terms regime because they are usually:

standard form (with little opportunity to negotiate the terms); and
for the supply of goods or services; and
entered into with a franchisee who meets the criteria of a ‘small business’ under the ACL; and
have an ‘upfront price’ payable to the franchisor of under $300,000 for an agreement less than 12 months in length, or $1,000,000 if over 12 months. Upfront price includes payments, fees and charges payable over the life of the agreement, which would include both the initial franchise fee payable when signing the franchise agreement and ongoing franchise or royalty fees payable for the duration of the agreement.

Importantly to note, the unfair contracts regime only applies to contracts entered into or renewed from 12 November 2016. It will not apply to a franchise agreement entered into before this time.

As many new and renewed franchise agreements will commonly be subject to the unfair contracts regime, ensuring a franchise agreement does not contain ‘unfair’ contract terms is essential.

What is an ‘Unfair Contract Term’?

A term in a contract will be considered unfair if it satisfies all the criteria set out in section 24 of the ACL. These criteria are:

the term would cause significant imbalance between the rights and obligations of the parties to the contract; and
the term is not reasonably necessary to protect the legitimate interests of the stronger party who would be advantaged by the term; and
if the term were to be relied on or used it would cause detriment (whether financial or otherwise) to the weaker party.

The term is also more likely to be considered unfair if it is not transparent, meaning the term is not expressed in plain language, is illegible, not clearly presented and not readily available to the other contracting party.

Which Types of Terms in Franchise Agreements may be Unfair?

The ACCC has noted the following as terms often found in franchise agreements that the ACCC may consider to be unfair:

Termination clauses that are unreasonably broad or unjust. For example, the ability to terminate the agreement in circumstances where the franchisee has not committed a breach of the franchise agreement.
Restraint clauses which apply when the franchise agreement ends. Of note will be the period of the restraint, the types of business the franchisee can be involved in, the conduct the franchisee is restrained from engaging in and the geographic area of the restraint. These will be considered unfair if the restraint goes beyond protecting the legitimate business interests of the franchisor. The wider the restraint, the more likely it is to be unfair.
Liquidated damages clauses that do not represent a genuine pre-estimate of loss for the franchisor if a franchisee defaults and the franchise agreement is terminated early. Liquidated damages are a set amount of money payable as damages to another party upon the happening of a certain event.
Clauses allowing the franchisor to unilaterally vary the terms of the franchise agreement without needing the mutual consent of the franchisee. Notably, franchise agreements often permit a franchisor to update their operations manual from time to time, with franchisees being obligated to comply with the change. The ACCC have been critical of franchisors who attempt to implement major changes to the obligations of franchisees by making those changes to the operations manual, rather than varying the franchise agreement. Therefore, requiring franchisees to comply with the franchisor’s unilateral changes to an operations manual may also amount to an unfair contract term where the elements of the ACL’s unfair contract term regime are met.

What are the Consequences of having an Unfair Contract Term?

The party who is disadvantaged by the unfair term (for example, the franchisee) can bring court proceedings against the party advantaged by that term (for example, the franchisor), and ask the court to make a decision about whether the term is unfair.

Alternatively, the ACCC can bring proceedings directly against the party who is advantaged by the unfair term.

If a court declares a term in a contract to be ‘unfair’ then that term will be void and unenforceable. If this occurs, that clause will be severed and the remainder of the contract will continue to operate without that unfair contract term.

For example, if a court held that a provision which entitled the franchisor to terminate the franchise agreement without a reason to be unenforceable, then the remainder of the franchise agreement would still stay in force. If the franchisor wished to terminate the franchise agreement, they would need to rely on the remaining provisions governing termination (such as first giving the franchisee notice of breach and a reasonable opportunity to remedy the breach).

Just because a franchise agreement contains a term which may fit the criteria of an ‘unfair’ term does not mean that term is automatically unenforceable. It must be declared to be unenforceable by a court.

Will an Unfair Contract Term contravene the Code?

At the time of writing this article in September 2018, major players in the Australian franchising industry are campaigning for amendments to the Code which would prohibit a franchise agreement from containing an unfair contract term. Rouse Lawyers will be following these developments closely and publishing further updates if such changes are implemented.

Franchisors should also be mindful of the obligation under the Code to act in good faith. If a franchisor acts outside of their own legitimate business interests and attempts to enforce a term in a franchise agreement meeting the criteria of an unfair contract term, the franchisor may alternatively be failing to act in good faith.

What does this mean from a practical perspective?

For the franchisor wishing to take advantage of the unfair term and use that term to the detriment of the franchisee, this means that the unfair term has the potential to be unenforceable while in all likelihood the remainder of the franchise agreement will continue to operate. Consequently, the practical result of having a clause declared unfair and unenforceable could be exposure to risk or the loss of a right under the franchise agreement.

By way of another example, if an indemnity clause in favour of the franchisor is too broad and goes beyond the necessary protection of the franchisor, it may be declared unfair. This may result in the entire indemnity clause being unenforceable, meaning that the franchisor loses the protection of being indemnified for the remaining time left on the franchise agreement. If, on the other hand, the indemnity clause was reasonable and not unfair, the franchisor would continue to have the benefit of protection under the indemnity clause.

Franchising Code of Conduct and Franchise Agreements

The Code also sets out requirements regarding items that must or must not be included in a franchise agreement.

What are the Requirements of the Franchising Code of Code?

Some of the rules the Code contains about such clauses include:

Franchise agreements must not require franchisees to sign a ‘general’ release from liability in favour of the franchisor or require a franchisee to sign a waiver of any written or verbal representation made by the franchisor. This means the franchise agreement cannot say that a franchisor is relieved from liability if they act negligently, and cannot say that promises made by the franchisor before the franchise agreement was signed are unenforceable. If either of these are contained in the franchise agreement they will be unenforceable regardless of whether the franchise agreement is signed by the franchisee.
A dispute resolution clause must not require mediation of a dispute to be conducted outside of Australia, or in a state or territory in which the franchised business is not based. This means that if the franchisee operates their business in Brisbane, then the franchisor cannot force the franchisee to attend a mediation at the franchisor’s head office in Sydney. Additionally, a clause cannot require an action or proceeding to be commenced outside of Australia, or in a state or territory in which the franchised business is not based. This means that if the franchisee operates their business in Queensland, then legal proceedings must be bought in Queensland. If such contravening clauses do exist they will be unenforceable and have no effect.
A franchise agreement must not include a clause requiring the franchisee to pay for the franchisor’s costs of settling a dispute under a franchise agreement. Such a clause will have no effect.

It is also prudent to ensure the requirements of the Code are reflected in the franchise agreement. By way of example:

A franchisor cannot unreasonably withhold consent to the transfer of a franchisee’s business.
If it’s a new franchise agreement and not a renewal or a transfer, then the franchisee is entitled to a 7 day cooling off period.
There are certain circumstances under the Code which entitle a franchisor to terminate a franchise agreement immediately, for example, a franchisee’s fraudulent behavior or certain events of insolvency. A franchisor can only rely on these circumstances to terminate a franchise agreement if the franchise agreement expressly contains a provision affording this right.

Reflecting these things in the franchise agreement can assist a franchisor avoid inadvertent non-compliance with the Code.

What are the Consequences of Non-compliance with Franchising Code of Conduct?

The consequences for non-compliance with the Code vary depending on the contravention. As noted, the inclusion of particular clauses in a franchise agreement, such as requiring franchisees to pay the franchisor’s legal costs of a dispute, results in that clause having no effect. Other contraventions may attract a court ordered financial penalty and undertakings (which can apply to both a company and its directors). A court ordered undertaking may include, for example, providing a notice on the franchisor’s website outlining the contravention and the steps consumers can take if they are affected by the contravention.

An alternative (or sometimes an addition) to court ordered financial penalties are ACCC issued infringement notices, penalties and undertakings. Breaches of some provisions of the Code will attract penalties of up to $63,000 in each instance, and these breaches may lead to infringement notices for $10,500 per breach. The values of these penalties are currently under review and are likely to increase.

Takeaways

Franchisors should consider whether their franchise agreement contains unfair contract terms and whether it fully complies with the Code. It is prudent for franchisors to have their franchise agreement reviewed by a specialist franchising lawyer.

It is also important for franchisees to be conscious as to whether their franchisor is complying with the Code, and that certain provisions in their franchise agreement have the potential to be unfair and unenforceable. Taking the time to consider this will assist franchisees to manage their business with more certainty.

There may still be freedom for franchisors to have a franchise agreement containing whatever terms they want, but there will not be freedom to enforce those terms if they are unfair or contravene the Code.

By Sonja van der Steen and Luke McKavanagh

The post Is Your Franchise Agreement Unfair? appeared first on Rouse Lawyers.

Wednesday, September 12, 2018

Key Changes to Insolvency Event Clauses

A Federal Government regime may affect the operation of insolvency clauses in contracts entered into from 1 July 2018. The types of clauses that may be affected are clauses that allow a party to terminate or change the operation of a contract if another party to that contract becomes insolvent.

Introduced primarily under the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth), the regime is commonly described as the ipso facto regime as it addresses clauses generally referred to as ipso facto clauses.

What is an ipso facto clause?

An ipso facto clause is effectively a bankruptcy or insolvency clause whereby a party is permitted to exercise its rights to terminate a contract due to the bankruptcy or insolvency of the other party.

How are insolvency clauses affected?

The ipso facto regime affects the bankruptcy or insolvency clauses in contracts by placing a stay on a party’s right to terminate or change the operation of the contract, unless excepted. That means that any action that can be taken by a party against another party (ie such as the right of one party to terminate the contract in the event of the bankruptcy or insolvency of the other party) would be put on hold, unless an exception applies.

Correspondingly, where a party has the right under a contract to an advance of money or credit from the other party, that party also has a stay on its right to require a new advance of money or credit from the other party.

What types of insolvency events are affected?

The following are examples of the types of insolvency events we have seen in contracts to which the ipso facto regime applies:

company arrangement – an arrangement between a company and the creditors of that company (for the purpose of avoiding being wound up) that is put in place to determine how the company’s affairs will be dealt with.
receivership – in the event a controller or manager is appointed in respect of all or part of a company’s assets.
administration – in the event a company is taken under the management of an appointed administrator.

How long does a stay on an ipso facto clause last?

The stay period commences when:

company arrangement – an application for a company arrangement is made (or, for a company, being the disclosing entity, an announcement relating to a company arrangement is made);
receivership – a controller or manager is appointed in relation to a receivership; or
administration – when a company is placed under administration.

The end of the stay period varies and is not clear. Subject to extensions, the stay on an ipso facto clause may end:

company arrangement – when the application for company arrangement is withdrawn (or when it is dismissed by a Court), when the company arrangement comes to an end (unless there is a resolution to wind up the company, in which case the stay period ends when the company is wound up) or, if a company (that is a disclosing entity) announces that it will make application for company arrange and does not make that application within three months of the announcement or three months after the announcement.
receivership – the control or the appointment of a controller and manager of the company’s assets ends; or
administration – when the administration of the company ends.

The stay period may be extended by order of a Court and may therefore continue indefinitely where, for example, a stay has been lifted because the reason for enforcing the right relates to the company’s financial position before the end of the stay period or before the company’s commencement of company arrangement, administration or receivership.

What are the Exceptions?

The ipso facto regime has excluded a wide range of contracts. The following list of contracts, (amongst others) are excluded from the ipso facto stay provisions:

arrangements relating to the sale of a business;
arrangements in relation to the management of financial investments;
arrangements relating to escrow accounts containing code and/or passwords for the operation of software (for access by the licensee in the event the licensor is subject to an insolvency event);
agreements, approvals and permits issued by the Commonwealth, a State or Territory, or a local government;
agreements for the supply of goods or services to a public hospital or health service;
a contract directly connected with a securities financing transaction; and
an agreement or arrangement entered into on or after 1 July 2018 but before 1 July 2023 that is a novation or assignment of some or all rights under an agreement, or a variation of an agreement.

Court may order a lift of the stay

A Court may make an order that a stay does not apply to any part of an ipso facto clause or to the whole of ipso facto clause. The Court may also order the lifting of the stay for a company arrangement if the Court is satisfied that the application was not made for the purpose of avoiding the winding up of the company.

For each company arrangement, receivership and administration the Court may order that the stay does not apply if the Court is satisfied that it is appropriate in the interests of justice. How the Court determines what is not in the interests of justice in respect of a company arrangement, receivership or administration is not entirely clear at this time.

What should you do?

You should review your existing contracts and agreements to see whether they are captured by the ipso facto stay provisions or whether they are within an exception. If you intend to rely on an exception, the wording of exceptions is open to interpretation and there has not been any real guidance or decisions from the court at this stage. Given the uncertainty in this area, we recommend you seek advice before taking any action.

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Thursday, September 6, 2018

Company Rollover – A Last Resort Option?

In the evolution of a business, there may come a time when it is necessary to restructure into a company. Often, non-tax factors will trigger this: government regulations, a need to attract equity investment, corporatisation leading to a potential buyout, or a need to fund working capital.

On the surface, a company rollover appears the ideal option – no CGT is triggered on the restructure, and the same tax attributes, including cost base, are maintained.

What is not often appreciated is the use of a company rollover can trigger a significant tax disadvantage which should be avoided. This arises because companies are ineligible for the CGT discount, for which natural persons and trusts are entitled. In addition the small business 50% reduction (one of the concessions in the Div 152 small business reliefs) is subject to tax on distribution by a company. For a structure with a single equity participant, the combined effect of these rules is a maximum exempt gain of $800,000 in a company and $2 million for natural persons.

Case Study

A business is operated by the Williams Family Trust (the same result applies if it were operated by a sole trader). George Williams is the controller and underlining owner behind the Williams Family Trust (or the sole trader that owns the business).

The business is considered to have a current market value of $1.2 million. The Williams Family Trust commenced the business from scratch and the cost base of goodwill is Nil. George is looking to introduce a business partner and his accounting advisers have recommended restructuring the business to a company. The restructure is implemented by way of a Division 122-A rollover under which shares with a market value of $1.2 million are issued to George (but under the rollover cost base rules, those shares have a cost base equal to the current cost base of the business, Nil). Note: there will be a cost base in respect of other assets, e.g. equipment.

A comparison of the tax results that would arise if there was a sale of the business immediately before and immediately after the restructure:

In essence, by using the company rollover has converted the unrealised gain on the business of $1.2 million from an exempt trust gain into a company taxable gain with an underlying tax liability on a subsequent sale of around $350,000.

Takeaway

A company rollover may appear simple and give the desired immediate result (nil tax restructure). However, it creates an underlying tax problem.

There are usually alternatives to get a better result. These include the use of the small business CGT concessions in Division 152, or an alternative that does not trigger a taxing event.

When considering a business restructure, contact one of our specialist solicitors for suitable options and expert advice.

By Domenic Festa (Accredited Tax Specialist and Chartered Tax Adviser)

NOTE: This article is for general information only and should not be relied upon without first seeking advice from one of our specialist solicitors.

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Wednesday, September 5, 2018

Company Rollover – A Last Resort Option?

On the surface, a company rollover appears the ideal option – no CGT is triggered on the restructure, and the same tax attributes, including cost base, are maintained.

Case Study

A comparison of the tax results that would arise if there was a sale of the business immediately before and immediately after the restructure:

Takeaway

A company rollover may appear simple and give the desired immediate result (nil tax restructure). However, it creates an underlying tax problem.

There are usually alternatives to get a better result. These include the use of the small business CGT concessions in Division 152, or an alternative that does not trigger a taxing event.

When considering a business restructure, contact one of our specialist solicitors for suitable options and expert advice.

By Domenic Festa (Accredited Tax Specialist and Chartered Tax Adviser)

NOTE: This article is for general information only and should not be relied upon without first seeking advice from one of our specialist solicitors.

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Is A Company The Most Suitable Structure in The Current Tax Environment?

When starting a business or contemplating a significant investment, the first consideration is which entity should be used for the ownership of that business/investment.

Traditionally, a common structure for private businesses was a discretionary trust. In the current tax environment, we find a standard recommendation of many advisers (in some cases, to all clients) is a company owned by a discretionary trust.

Is this a suitable structure recommendation?

What has changed?

Division 7A contains a group of provisions that tax loans by private companies as unfranked dividends unless there are annual repayments over a seven year period (or 25 years if sufficient real estate security is provided).

Under the traditional structure of a discretionary trust, it was accepted that trust income could be taxed at the company tax rate by making distributions to a private company beneficiary that was not paid.

Prior to December 2009, the ATO accepted that unpaid distributions were not loans and were not required to be repaid within a stipulated period. The ATO changed its view in December 2009 and considered unpaid distributions were financial accommodation and within the extended meaning of loan.

Key structure factors

The key factors that are sought for a desirable structure are:

Rate of tax not significantly more than the company tax rate;
Protection of assets in the event of a claim against equity owners;
Limited liability;
Allows introduction of new equity participants;
Maximum entitlement to CGT concessions (50% CGT discount and small business CGT concessions);
Income splitting and distribution flexibility;
Tax preferences can pass to beneficiaries/members without additional tax;
Not subject to Division 7A.

So how do each of the structure alternatives 1. Company owned by a Discretionary Trust (DT) Traditional Discretionary Trust, compare on our key structure factors?

The clear point from the above table is trusts are the preferred vehicle for capital appreciating assets (including goodwill of a business), and the only advantage of a company structure is the rate of tax and the introduction of new equity participants. However, that advantage is only relevant if funds are required for working capital. Small trading companies (referred to as base rate entities) are taxed at 27.5%, and other companies at 30%.

The effect of the change in the ATO view is that trust income must generally be distributed and taxed to natural persons. The tax rates that apply to natural persons is at a taxable income of $90,000 a marginal rate of 34.5% (less the low and middle income tax offset), but lower rates for income below $37,000. To draw a comparison with the company rates, a natural person has an average rate of tax (at 2018/2019 rates) of 27.5% for income of $108,722, and 30% for income of $138,922.

Structure Recommendation

In the case of a couple (husband and wife, defactos, same-sex couples), there is little advantage for incomes up to $217,444 ($108,722 x 2).

The income generated from a business may be considered to fall within three separate phases:

initial start-up, at which time the income may be personal services income and not able to be split;
income is no longer considered personal services income, is considered business income below the threshold in the previous paragraph $217,444;
the business is generating income above those thresholds.

Since the preferred vehicle for holding capital appreciating assets is a trust, it will usually be preferable to own the business through a trust structure. When the level of income reaches the point where the company tax rate is desirable, the structure should then be split between capital ownership in a trust and income generation in a company.

In that light, a better option is a structure which evolves through the three phases in the following manner:

structure at start-up is in the form of a discretionary trust even if income generated is personal services income. This approach avoids having to restructure the business when it reaches phase 2;
when the business moves to phase 2, no change to the structure is required to split income;
when the business moves to phase 3, split the structure between capital ownership in a trust and income ownership in a company. The splitting can be implemented with an appropriate Licence Agreement between the trust (asset owner) and an operating company, drafted in sich a manner that does not trigger tax on the grant of the licence. Alternatively, rollovers can be utilised to restructure into a corporate entity, when and if the business reaches this phase.

By Domenic Festa (Accredited Tax Specialist and Chartered Tax Adviser)

NOTE: This article is for general information only and should not be relied upon without first seeking advice from one of our specialist solicitors.

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