Franchising Code: What Does a Reasonable Opportunity to Make a Return Mean?

Under recent changes to the law, franchisors cannot enter into franchise agreements that do not give franchisees a reasonable opportunity to make a return on the investment required by the franchisor.

To unpack these rules, I’m joined by Edward Hart, Senior Associate in Velocity Legal’s Commercial team. Welcome to the podcast, Ed.

Edward Hart:
Thanks, Andrew. Thanks for having me.

Andrew:
Can you unpack the rule? I may have simplified it slightly in the introduction. What does it require, and where has it come from?

Edward:
Franchisors cannot enter into or renew a franchise agreement if they consider there is no reasonable opportunity for the franchisee to make a return on any investment required by the franchisor.

The two questions that naturally follow are: what is a return, and what amounts to a reasonable opportunity?

The requirement was introduced with the new Franchising Code in April 2025. It formed part of a broader group of changes intended to protect franchisees, but this is one of the changes causing the greatest concern for franchisors.

The current maximum penalty is 600 penalty units, which is approximately $200,000, although the value of a penalty unit is subject to change. The potential penalties are therefore significant.

Andrew:
Were these changes driven by a review or consultation process?

Edward:
An independent review conducted in 2024 identified an unfair power imbalance between franchisors and franchisees.

The new requirement is intended to discourage franchisors from knowingly allowing a franchisee to enter a business opportunity with serious commercial problems. However, the precise threshold is not yet clear.

The issue is whether a franchisor should permit a franchisee to enter into an agreement where the franchisor knows that a particular site or opportunity has material risk factors.

Andrew:
There are several difficult questions within that. What period is reasonable? What constitutes a return? How do franchisors deal with inflation, changing costs and broader economic uncertainty?

What guidance do we currently have?

Edward:
The guidance is limited.

The ACCC has said that a reasonable opportunity is what a reasonable person would regard as a reasonable opportunity. That is a familiar legal test, but it does not provide franchisors with much certainty.

The ACCC has also identified several relevant factors. These include the location of the franchise, the level of local competition and the significant capital expenditure the franchisor requires.

Capital expenditure is particularly important. If a franchisor requires a franchisee to spend several hundred thousand dollars on an initial refurbishment but offers only a two-year agreement, it is unlikely that the franchisee will have enough time to recoup that investment.

The ACCC has indicated that franchisees should have an opportunity not only to recover their investment, but also to make an ongoing profit.

Edward:
The ACCC has provided an example involving a fast-food restaurant.

The franchisor required a significant upfront investment. Based on forecasts and industry data, it was expected to take the franchisee approximately four years to recover that initial investment.

The ACCC indicated that a five-year agreement would not provide a sufficient opportunity to make a return. The franchisee would spend four years recovering the investment and have only one remaining year in which it might make an ongoing profit.

It is a relatively simple example, but it highlights that the agreement term is critical.

One of the first matters a franchisor should consider is whether the term gives the franchisee a genuine opportunity to recover the initial investment, meet ongoing costs and then make a return.

Andrew:
Do you expect this requirement to become an issue when a franchise business fails?

A franchisee may later argue that there was never a reasonable opportunity to make a return, even where the failure resulted from other factors.

Edward:
I expect franchisees may rely on the provision as a fallback where a business does not perform as expected.

That can be difficult for franchisors because, in most cases, franchisors want franchisees to succeed. It would be a poor business model for a franchisor to want businesses within its network to fail.

However, franchisors still need to comply with the Code and document the conversations they have with prospective franchisees.

Where a franchisee’s own conduct or management contributed to the failure, it may be unfair for the franchisor to be blamed. Even so, I expect these arguments will be raised in future disputes.

Andrew:
What should franchisors do to manage the risk?

Edward:
The starting point is the discussion between the franchisor and prospective franchisee.

From the beginning, franchisors should identify and discuss any risks specific to the site and any significant capital expenditure that will be required.

Significant capital expenditure is also addressed separately under the Code. The franchisor should explain:

• what expenditure will be required;
• why the expenditure is required;
• the commercial rationale for it; and
• how long the franchisor considers it may take the franchisee to recoup that amount.

This creates a significant compliance burden, but those discussions are important.

Andrew:
That sounds similar to preparing a financial model. Is the franchisor required to provide forecasts?

Edward:
The Code does not require a franchisor to provide forecasts.

However, in my view, the reasonable opportunity requirement may require franchisors to turn their minds to forecasts or financial assumptions for a particular site.

That creates a tension. A franchisor may need to undertake that analysis to satisfy itself that there is a reasonable opportunity, while separately deciding whether the forecast should be provided to the franchisee.

If forecasts are provided, the franchisor also needs to consider the assumptions on which they are based and the level of detail disclosed.

Franchisors should speak with their accountants before meeting with prospective franchisees. Accountants may identify commercial or financial risk factors that need to be considered and discussed.

Legal advice may then be required regarding whether financial information is being provided in the prescribed form and how the associated risks should be addressed.

Andrew:
What are franchisors doing in practice to address the requirement?

Edward:
Much of the work needs to occur before the documentation stage.

Franchisors should discuss the risks associated with the site and assess whether the prospective franchisee is suitable for the business.

We are also seeing franchisors place greater emphasis on franchisee vetting.

If a franchisee is not suited to operating the business, that may create problems for the network and potentially give rise to later arguments about the opportunity that was offered.

Franchisors should refine their selection processes and establish clear criteria that prospective franchisees need to satisfy before discussions progress too far.

Andrew:
The ACCC is responsible for enforcing the Franchising Code. It may be too early to know how it will approach this requirement, but where do you expect the greatest enforcement risk?

Edward:
The uncertainty is a major concern for franchisors because there is not yet much case law.

If I were to predict the likely areas of focus, I would expect the ACCC to look closely at the length of the agreement and significant capital expenditure.

Franchisors commonly require refurbishments at the beginning of an agreement or after a specified period. Given current construction costs, those refurbishments may involve substantial expenditure.

The ACCC may ask:

• why the expenditure was required;
• how the amount was justified; and
• how much of the agreement term remained after the expenditure was incurred.

The requirement does not guarantee a particular level of profit or a specified percentage return.

However, the current guidance indicates that the franchisee should have an opportunity to recover the required expenditure and then make an ongoing profit.

Until relevant cases are decided, there will continue to be uncertainty about precisely where the line is drawn.

Andrew:
It is not uncommon for a business to become distressed and then be sold to another operator.

How does the requirement apply where an existing franchise business has a track record of not making a return and a new franchisee wants to acquire it?

Edward:
This is another significant tension point.

When an existing franchisee sells the business, the franchisor generally needs to approve the incoming franchisee and either enter into a new franchise agreement or approve an assignment of the existing agreement.

Where the business is underperforming, the franchisor needs to assess why.

The franchisor should consider how much of the underperformance is attributable to the outgoing franchisee’s management and how much is attributable to risks inherent in the site or business.

For example, the site may have an unusually high concentration of competitors.

If site-specific risks are the primary cause of the underperformance, approving a new franchisee may mean allowing that person to enter an agreement where there is no reasonable opportunity to make a return.

The franchisor should document the issues identified, discuss them with the prospective incoming franchisee and consider whether there are practical strategies for addressing them.

It is a difficult assessment and one on which franchisors should obtain advice.

Andrew:
What are the main priorities for franchisors seeking to comply with these rules?

Edward:
First, have the relevant discussions with prospective franchisees from the beginning.

Second, identify and discuss any significant capital expenditure required at the start of the agreement or during its term.

Third: document, document, document.

Franchisors should retain records of the conversations, the rationale for each required expense and how the expenditure and associated risks were discussed with the franchisee.

They should also seek input from their accountants regarding financial and site-specific risk factors and obtain legal advice where necessary.

Andrew:
Ed, thank you for joining us.

We have discussed the requirement to provide franchisees with a reasonable opportunity to make a return and the potential penalties for non-compliance.

Anyone with questions about these rules or franchising more broadly is encouraged to contact Edward or Velocity Legal’s Commercial team.

Thanks again.

Edward:
Thanks, Andrew.