The Franchise Debt Trap: What Both Sides Need to Know Before the Lawyers Arrive

Of all the commercial relationships that generate debt disputes in Australian business, few are as legally complex or as financially damaging as those between franchisors and franchisees. The franchise relationship involves long-term contractual obligations, significant upfront investment, ongoing fee structures, and a fundamental power imbalance that Parliament has repeatedly intervened to address. When money stops flowing in either direction, the consequences can be severe for both parties.

From 1 April 2025, the regulatory landscape governing those disputes changed substantially. The Competition and Consumer (Industry Codes—Franchising) Regulations 2024 (Cth) the new Franchising Code of Conduct, replaced the 2014 Regulation and introduced stronger protections, expanded civil penalties, and a revised dispute resolution framework that every franchisor and franchisee pursuing or defending a debt claim must now navigate. A further tranche of amendments took effect on 1 November 2025, including new requirements around a franchisee's reasonable opportunity to earn a return on their investment.

Understanding how the new Code shapes the pursuit and defence of franchise debt claims is not optional. Non-compliance with the Code's procedural requirements can affect the enforceability of claims, expose parties to civil penalties, and significantly alter the cost dynamics of any dispute.

What Franchise Debt Looks Like

Franchise debt arises in several distinct forms, each with its own contractual basis and legal character.

Ongoing fees and royalties are the most common source of dispute. Most franchise agreements require the franchisee to pay a periodic royalty, typically a percentage of gross or net turnover together with contributions to a marketing or cooperative fund. These amounts are ongoing, contractually fixed, and frequently the subject of dispute when the franchise business underperforms. A franchisee who is struggling commercially will often stop paying fees before taking any formal step to exit the relationship.

Initial franchise fees and fitout contributions are typically paid upfront. Where a franchisee claims misrepresentation in the sale process and seeks to unwind the transaction, these amounts become the subject of competing claims: the franchisor seeks recovery of unpaid ongoing fees, while the franchisee counterclaims for return of the initial fee on the basis of misleading and deceptive conduct.

Termination-related debts can include fees payable on early termination of the agreement, make-good obligations, and obligations to cease using the franchisor's intellectual property and systems. These are often significant, and disputes about their quantum or whether the termination itself was valid generate some of the most contested franchise litigation.

Third-party obligations complicate matters further. A franchisee's business typically involves lease obligations, supplier contracts, and employment obligations that sit alongside the franchise agreement itself. When a franchise fails, these obligations do not disappear simply because the franchise has ended. In certain circumstances, the franchisor may also face exposure for the franchisee's obligations, a risk that has grown with the expanded liability framework applicable to responsible franchisors under the Fair Work Act 2009 (Cth).

The New Code: Mandatory Dispute Resolution Before Court

One of the most practically significant features of the new Code carried over and reinforced from the previous regime is the mandatory dispute resolution process. Before either party may commence legal proceedings to recover a franchise debt, the Code requires them to follow a structured process.

A party wishing to invoke the dispute resolution mechanism must first give the other party a written notice of dispute, setting out the nature of the dispute and the outcome the notifying party is seeking. The parties are then required to attempt to resolve the dispute by direct negotiation. If direct negotiation does not resolve the dispute within the specified period, either party may refer the matter to the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) for mediation or conciliation.

Under the 2024 Regulations, the ASBFEO's role in facilitating this process has been strengthened. The Ombudsman can now publish the names of franchisors who refuse to engage with or withdraw from the alternative dispute resolution process, a significant reputational deterrent for franchisors who might otherwise seek to avoid or delay the mediation step. The Ombudsman does not decide the merits of the dispute; that remains for the parties or, ultimately, for a court or arbitrator.

The consequence of failing to comply with the mandatory dispute resolution process is not merely procedural inconvenience. A franchisor who commences proceedings to recover unpaid fees without first following the Code's dispute resolution requirements may find those proceedings challenged, may be exposed to civil penalties, and may undermine the strength of their own claim. Equally, a franchisee who fails to give a notice of dispute in the correct form and within the applicable time limits may lose important rights, including the right to challenge a termination that would otherwise have grounds for challenge.

The Franchisor's Position: Recovering Unpaid Fees

For a franchisor seeking to recover unpaid royalties, marketing levies, or other fees from a defaulting franchisee, the contractual foundation of the claim is usually clear. The franchise agreement will specify the amounts payable, the frequency of payment, and the consequences of non-payment, including the right to issue a breach notice, to terminate the agreement on default, and to pursue the outstanding amounts as a debt.

The franchisor's position in litigation is, in principle, a strong one. Unpaid fees are a straightforward debt claim founded on a written contract. Where the amounts are liquidated that is, where they can be calculated by reference to specific figures in the agreement rather than requiring any assessment of loss, the franchisor may be able to obtain default judgment relatively quickly if the franchisee does not defend the claim.

But two features of the franchise landscape consistently complicate what might otherwise be a simple debt recovery exercise.

The first is the counterclaim risk. In practice, a franchisee who is sued for unpaid fees will frequently file a counterclaim alleging misrepresentation in the pre-contractual disclosure process, misleading or deceptive conduct, or breach of the franchisor's good faith obligation under the Code. The new Regulations reinforce the good faith obligation requiring both parties to act honestly, with genuine regard for the other's interests, and not to act for any purpose other than a legitimate commercial purpose. A franchisee who can establish that the franchisor misrepresented projected earnings, concealed material information in the disclosure document, or engaged in unconscionable conduct in the lead-up to the agreement may not only defend the debt claim but succeed on a substantial counterclaim for damages.

The Victorian Court of Appeal's decision in Bill Baxter's (Franchising) Pty Ltd v Pollard (unreported) is illustrative: a franchisor who sued for $250,000 in unpaid fees ultimately faced a $1.22 million damages award against it after the Court found that the projected turnover figures provided to the franchisee before signing had been made without any reasonable basis. The franchisor's debt claim was effectively extinguished by the counterclaim.

The second complication is the legal costs restriction. Under section 65 of the new Regulations, a franchisor is prohibited from requiring a franchisee to pay the franchisor's legal costs in relation to the franchise agreement, including costs incurred in settling or pursuing disputes under the agreement. Section 66 reinforces this, prohibiting a franchisor from entering into a franchise agreement that requires the franchisee to bear the franchisor's dispute resolution costs. This restriction applies to franchise agreements entered into on or after 1 April 2025, though the practical effect of equivalent provisions under the 2014 Regulation has been felt for some time.

The consequence for franchisors is significant: a franchisor who recovers unpaid fees through litigation may find themselves entitled to the debt but unable to recover the substantial legal costs of the proceedings from the franchisee, a result that materially alters the economics of pursuing smaller claims.

The Franchisee's Position: Defending a Debt Claim

For a franchisee facing a demand for unpaid fees, the first question is whether the amounts claimed are actually owed. Franchise agreements are complex documents, and the calculation of royalties, marketing levies, and other periodic fees is sometimes contested, particularly where the franchisor alleges amounts based on estimated rather than actual turnover or where the franchisee disputes the validity of adjustments or charges applied to their account.

Beyond the arithmetic of the claim, a franchisee has a range of potential defences and counterclaims available under both the franchise agreement and the broader legal framework.

Misleading and deceptive conduct under the Australian Consumer Law remains one of the most potent weapons available to a franchisee. Where the franchisor or its representative made representations about the likely financial performance of the franchised business, including representations about turnover, profit, or the success of comparable outlets that were not made on reasonable grounds, the franchisee may have a claim for damages that offsets or extinguishes the franchisor's debt claim. The new Code's expanded disclosure requirements and the obligation on franchisors to include additional information about significant capital expenditure in disclosure documents strengthen the evidentiary framework for such claims.

Breach of the good faith obligation under the Code provides a further basis for defending or counterclaiming. Good faith, as understood under the Code, requires each party to act honestly and in a manner that gives genuine consideration to the other's interests. A franchisor who issues a demand for unpaid fees while simultaneously engaging in conduct designed to pressure a franchisee into surrendering the franchise, a practice sometimes described as "churning" may be found to have breached its good faith obligation, with consequences for the enforceability of the debt claim.

The notice of dispute mechanism also provides a franchisee with tactical leverage. A franchisee who issues a notice of dispute in response to a demand for unpaid fees activates the mandatory dispute resolution process, which must be completed before the franchisor can issue proceedings. The minimum notice periods built into the Code give the franchisee time to obtain legal advice, seek alternative dispute resolution, and put their defence in order before the matter reaches court.

Personal Guarantees: The Hidden Liability

In the overwhelming majority of franchise agreements, the obligations of the franchisee entity are personally guaranteed by the directors or principals behind it. A franchise agreement entered into by a company, as most are, will typically be supported by a deed of guarantee and indemnity under which the individual directors agree to be personally liable for all amounts owed by the franchisee company to the franchisor.

This personal guarantee arrangement means that when a franchise fails and the franchisee company has no assets to meet the franchisor's claim, the franchisor's debt claim does not die with the company. It flows through to the guarantors personally. For the directors of an unsuccessful franchise, this can mean personal liability for amounts that would otherwise have been absorbed by the corporate structure.

The guarantee provisions in franchise agreements often survive the termination of the franchise itself and may extend beyond the agreement's nominal term. A guarantor who steps out of the franchise business whether by sale, assignment, or termination, should ensure that the guarantee is formally released as part of any exit arrangement. A guarantee that is left in place after the franchisee has exited may expose the former director to claims arising from the conduct of whoever subsequently operates the franchise, even without their knowledge or involvement.

The New Return on Investment Obligation

From 1 November 2025, the new Code introduced a requirement that franchisors provide franchisees with a reasonable opportunity to achieve a return on their investment. This provision, new to Australian franchising regulation, creates a potential basis for challenging fee demands or termination decisions where a franchisee can establish that the franchise system was structured or operated in a way that made a return on investment objectively impossible.

The Code does not define "reasonable opportunity" with precision it will depend on the industry, the investment size, the operating model, and market conditions. But the existence of the obligation introduces a new layer of accountability for franchisors whose business models depend on collecting fees from franchisees in markets that cannot sustain those fees. For franchisees carrying significant debt incurred in establishing the franchise, the return on investment obligation may provide a basis for challenging fee demands that they would previously have had to either pay or risk termination.

Practical Steps in a Franchise Debt Dispute

The dynamics of a franchise debt dispute are rarely as simple as the law of debt recovery might suggest. The mandatory Code process, the good faith obligation, the prohibition on cost recovery, the counterclaim risk, and the personal guarantee exposure all interact in ways that make early, careful legal advice essential for both sides.

For a franchisor facing a franchisee in default, the key steps before commencing recovery action are to verify that the mandatory dispute resolution process has been followed correctly, to review the original disclosure document for any representations that could ground a counterclaim, and to ensure that the amounts claimed are capable of precise calculation and documentation. A debt claim that cannot survive a counterclaim is not a strong platform for litigation.

For a franchisee facing a demand for unpaid fees, the key steps are to issue a formal notice of dispute as quickly as possible to activate the Code's protections, to obtain an independent review of the amounts claimed against the terms of the agreement, and to assess whether the circumstances of the original sale give rise to any claim for misrepresentation or failure of disclosure. A debt dispute that appears straightforward for the franchisor may contain significant defences that are only identifiable through careful analysis of the pre-contractual process.

The franchise relationship, even in dissolution, is governed by law that has been specifically designed to address the imbalance of power between the parties. The new Code is a significant strengthening of that framework. Parties who engage with it properly and promptly are substantially better placed than those who treat a franchise debt dispute as a simple commercial recovery matter.

Shire Legal is a boutique law firm based in Miranda, NSW, specialising in property, business and estates law. This post is intended as general legal information only and does not constitute legal advice. You should seek advice specific to your circumstances before taking any action. The new Franchising Code of Conduct applies to agreements entered into, transferred, renewed or extended from 1 April 2025; agreements entered into before that date may remain governed by the former 2014 Regulation until they are transferred, renewed or extended.