Global Trends in Franchise Regulation

8/22/2019 Global Trends in Franchise Regulation

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Global Trends in Franchise

Regulation and the Australian

Experience:

Lessons for New Zealand.

Andrew Terry

School of Business Law and Taxation

Australian School of Business UNSW

Franchise Law Reform Symposium

New Zealand Governance Conference

University of Auckland

25 June 2009

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The Regulatory Debate

The increasing influence of franchising has beenaccompanied by an increasingly vigorous international

debate as to the regulatory environment for franchising.

Does an effective legal environment for franchising

require a regulatory regime dedicated to the franchising

sector?

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In a perfect world we would not have

franchising at all because I think they are allnonsense

J R Rau MP

Member of the Economic and Finance

Committee of the Parliament ofSouth Australia, Franchising Inquiry,

Hansard, 10 October 2007

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The Regulatory Issues

Franchises are not ordinary commercial contracts.

These were not ordinary commercial

contracts but contracts giving rise to longterm mutual obligations in pursuance of

what amounted in substance to a joint

venture and therefore dependent upon

coordinated action and cooperationPrivy Council in Dymocks

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Relational and standard form characteristics.

The extra-legal norms which explain relational

contracting are less compelling in the context of the

typical business format franchise which is characterisedby both an information imbalance and apower

imbalance.

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The Relational Dimension

the business context.

Empirical studies by Macaulay(US 1960s) / Beale

and Dugdale(UK 1970s) suggest that:

Detailed negotiated contacts interfere with the creation of good

business relationships. Businessmen largely operate in a contractual vacuum and do not

behave as classical contract theory would lead us to believe.

People engaged in business often find that they do not needcontract planning and contract law because of relational

sanctions. Even discrete transactions take place within a setting of

continuing relationships and interdependence. The value of theserelationships means that all involved must work to satisfy eachother. Macaulay

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the legal context

Increasing recognition that traditional contract doctrineunsuitable for relational contracting.

Law and Economics School took up challenge of adopting modern

Contract Law to commercial reality (Macneil 1978, Goetz and

Scott 1981, Hadfield 1990) Relational contract theory developed to explain adequately the

nature and function ofrelational contracts and how they differ

from more standard contacts. (Goetz and Scott)

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Contractual Analysis

Traditional Classical Contract

Theory Relational Contract Theory

Important terms of the

contract are reduced to well-

defined obligations which areinterpreted and enforced

without reference to

associated but external legal

norms

Obligations arise not only from

written document but from thenorms of the ongoing relationship

which supplement the written

terms

Delivers predictability and

certainty albeit at cost of

disregarding legitimate

business expectations

Parties should be accorded

reasonable security for the

protection of justified expectations

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What is a relational contract?

the existence of a business relationship between the parties and the need to

maintain that relationship

the difficulty of reducing important terms to well defined obligations

the impossibility of foretelling all the events which may impinge upon the

contract

the need to adjust the relationship over time to provide for unforeseen factors

or contingencies which cannot readily be provided for in advance

the commitment, likely to be extensive, which one party must make to the

other, including significant investment;

incomplete in failing to allocate, or allocate optimally, the risk between the

parties in the event of certain future contingencies.

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Relational Factors:

relationship (rather than mere exchange or transaction)

continuing and long term

interdependence

cooperation

communication

mutual trust/confidence

respect

flexibility

reliance

highly interactive

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A relational contract is one which involves not merely an

exchange but a relationship between the contractual parties. The

parties are not strangers in the accepted sense and much oftheir interaction takes place off the contract requiring a

deliberate measure of communication, co-operation, and

predictable performance based on mutual trust and confidence.

Expectations of loyalty and interdependence mark the formation

of the contract and become the basis for the rational economic

planning of the parties.

Thomas J, dissenting, in Bobux Marketing Limited v Raynor Marketing Limited[2002] 1 NZLR

506, 516 (Court of Appeal) adopted by Bolland J in Gough & Gilmour Holdings Pty Limited vCaterpillar of Australia Limited (No 11) [2002] NSW IR Comm 354 (NSW Industrial Commission)

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Is Franchising a Relational Contract?

Franchising presents as the archetypal example of a relationalcontract.

It exists in a world of contractual incompleteness and relationalcomplexity in which

the parties are not strangers; much of their interaction

takes place off the contract, mediated not by visible terms

enforceable by a court, but by a particular balance of co-

operation and coercion, communication and strategy

Hadfield

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Consequences of relational categorisation

controversial

contractual obligations are often modified, supplemented or completelyoverridden by the norms of the on-going relationship

doctrinal tool relied upon to bring the resolution of franchise disputes inline with realities of the franchise relationship is invariably the implied

term of good faith.The norms of the ongoing relationship, of necessity, tend tosupplement the express contractual obligations. Good faith isrequired to ensure that the requisite communication, co-operationand predictable performance occurs for the advantage of bothparties. In short, the obligation seeks to hold the parties, to the

promise implicit in a continuing, relational commercial transaction.Thomas J in Bobux

a work in progress

regulation necessary to free parties from the dubious mercy of classical

bi-lateral contract law (Hammond J in Dymocks) 13


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The Standard Form Dimension

information imbalance

power imbalance

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The Regulatory Challenge

Entrepreneurship and business creation in a free societynecessarily includes an element of risk and it should certainly notbe the role of Government to remove risk. Nevertheless inparticular circumstances of franchising there are elements quitedifferent to normal business development because of the control ofthe franchisor which can be an overriding risk for the other thanpurely business or commercial reasons.

Those special additional risks arising in part because of the balanceof power in the franchising relationship should be minimised whileleaving the commercial risks and decision to be handled by theparties concerned

Council of Small BusinessOrganisations in Australia,

Submission on First Exposure Draft of

1986 Franchise Agreements Bill

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franchising is a unique and proven model for business

development

entrepreneurship involves risk

not the role of government to remove risk

But in the particular circumstances of franchising: Are there elements quite different to normal business

development because of the control of the franchisor which can

be an overriding risk for other than purely business or

commercial reasons?

How can these additional risks be minimised while leaving the

commercial risks to be handled by the parties?

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The Regulatory Strategies

Registration

Prior disclosure

Regulating conduct in the relationship

Dispute resolution

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Registration

from full audit to mere filing/recording

applies in various jurisdictions to either franchisor, franchisee,

franchise contract, or franchise activities

annual reporting requirement common

disadvantage of imprimatur of competence

advantage of statistical data base

annual filing of disclosure document?

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Prior disclosure

No law can, or should, act to prevent the holding or seeking of high

aspirations, however unlikely to be satisfied. However, it has been a longstanding philosophy of free enterprise government that it is a legitimate

role of government to provide, or cause by law to be provided, an

accurate informational framework within which individual aspirations

are formulated .

Trade Practices Consultative Committee 1979 adresses the information imbalance

facilitates due diligence

UNIDROIT Model Disclosure Law 2002

wide acceptance

uncontroversial

not a restriction on business but a common sense and firm basis for doing business

within the peculiarly close relationship of a franchise and in accordance with normal

business practice.

extent/degree of disclosure contentious

compliance costs 19


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Regulating conduct in the relationship

more controversial fairness and allocation of risk in entrepreneurial activity

encroachment of freedom of contract

uneven acceptance

no universal precedent

function of disclosure to warn of unduly onerousobligations

variety of approaches prescribed rights and obligations

general standards of conduct

specific standards of conduct

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Dispute resolution

generally required to be addressed in agreement or via priordisclosure

mediation process as prerequisite to litigation or arbitration

except in limited circumstances

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The international regulatory experience

voluntary self-regulatory Codesof Practiceadopted by national franchise associations

franchise specificregulation

Mandatoryregulation by law

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The regulated sectors internationally

23Note: Year is of first franchise regulation.

Note: Little uniformity in nature, extent, scope and comprehensiveness of regulation

Albania 1994

Australia 1998

Barbados 1975

Belarus 1998Belgium 2006

Brazil 1994

Canada

Model Law 2005

Alberta 1980

Ontario 2001New Brunswick 2007

PEI 2007

China 1997

Croatia 2003

Estonia 2002

France 1991Georgia 1997

Indonesia 1997

Italy 2004

Japan 1983

Kazakhstan 2002

Korea (South) 1997

Kyrgyzstan 1998

Lithuania 2000

Macau, China SAR 2000Malaysia 1998

Mexico 2001

Moldova 1997

Romania 1997

Russia 1996

Saudi Arabia 1992

Spain 1996

Sweden 2006

Ukraine 2004

Taiwan 1999

USA

federal 1979

state 1970

Venezuela 1992

Vietnam 2006

Unidroit Model Law 2002


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The regulatory models

Disclosure

Belgium

Brazil

France

Japan

Sweden

Taiwan

Disclosure & Conduct

Albania

Canadian provinces

Georgia

Italy

Romania

Disclosure & Registration

Indonesia

Mexico

Spain

Disclosure, Registration & Conduct

China

Macau

Malaysia

Moldova

Vietnam

Disclosure, Conduct & DisputeResolution

Australia

Korea

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Registration

Croatia

Barbados

Registration & Conduct

Belarus

Kazakhstan

Kyrgyzstan

Saudi Arabia

USA

Disclosure: federalConduct: federal (auto/petrol) and

most states (general, sectoror issue specific)

Registration: state (14 states)

Conduct

Estonia

Lithuania

Russia

Ukraine

Venezuela


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The regulatory experience in Asia

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regimes

Australia

China

Korea

Malaysia

Vietnam

minimalist regulatory regimes

Indonesia

Japan

Kazakhstan

Kyrgyzstan

Macau SAR

Russia

Saudi Arabia

Taiwan

sector self regulation

Hong Kong

India

New Zealand

Philippines

Singapore

regulation imminent?

India

New Zealand


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Registration

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Australia China Korea Malaysia Vietnam

registrationrequirement

filing/recording onsubmission of

documentation

audit andregistration

annual reporting


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Prior disclosure

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franchisee priordisclosure

franchisor priordisclosure

franchisorcontinuingdisclosure

days pre contract /payment

14 30 5 10 15

prescribeddisclosuredocument

warning/advice tofranchisee


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Prior disclosure items

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contract issues

reference to / summary of key

contract obligations

non contract issues

franchisor information /experience / litigation

start-up costs

general sector information

existing franchise network

non-renewals / terminations /

transfers / buy-backs, ceasingoperation

material

litigationandarbitration

termination

earnings claimsjustify if

given

justify ifgiven

franchisor financial

statements


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Conduct

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general

standards ofconduct

good faith good faith

best business

practice

termination notice

term / renewalterm (3 years

minimum)renewal (noticeof non renewal)

transfer

other

franchiseeright toassociate

prohibition ofgeneralrelease of

liability marketing

funds

copy ofassociatedlease

confidentiality dutiesconsolidated

Unilateralamendment

confidentiality

post terminationrestraints

conduct notreasonable toprotectlegitimatebusinessinterests

dutiesconsolidated


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Franchise agreement

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Mandatory content *

Cooling off

Certification reindependent advice

* prior disclosure of specific contractual obligation


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Dispute resolution

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Mediation as pre-requisite to litigation /arbitration


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Other pre-conditions to franchising

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none

two stores/one year

operation for one year

general discretion to

refuse registration


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increasing recognition that in the special circumstances of franchising

there are elements sufficiently different to normal businessdevelopment to justify regulation clear trend to regulation no consistent regulatory strategy no consistency within a particular strategy prior disclosure laws widely adopted

no meaningful franchisor constituency for not supporting pre-sale disclosureUnidroit Model Lawsymbolicalmost universal acceptancelittle uniformity in extent of disclosure

conductlaws increasingly common and surprisingly uncontroversial registration laws most common in developing sectors (US the

exception) no horror stories no standard form template for regulation

policy objectives in developing economies

The international experience

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The Australian Regulatory Experience

The Australian regime is draconian, too wide ranging in itsapplication, costly in terms of compliance and often ineffective in

terms of providing relevant protection to franchisees and

potential franchisees.

FANZ, ORFR para 19

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The new Australian regulation makes Australia the leastdesirable destination in the world for franchise systems .

[Franchisors] should avoid Australia until they have nowhere

else to go and even then it would be a close call.

Martin Mendelsohn 1999

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Australian

franchise

sector

Commercial laws

of general

application

General regulation

through legislative

prohibition of

misleadingandunconscionable

conduct

Specific regulationunderFranchising Code

of Conduct

General regulation

through term ofgood

faith implied at law asa necessary incident

of a franchise

contract

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The Franchising Code of Conduct

mandatory prior disclosure prior disclosure document containing over 200 items of information

continuing disclosure of key information

no recording / vetting / registration

mandatory regulation of particular conduct / relationship issues:

7 day cooling-off period

freedom to associate with other franchisees

prohibition on any general release of the franchisor from liability

disclosure requirements regarding marketing funds

freedom for the franchisee to transfer franchise

restrictions on the franchisors right to terminate

mandatory mediation

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Misleading or deceptive conduct

A corporation shall not, in trade or commerce, engage inconduct that is misleading or deceptive or likely to mislead

or deceive

s52 Trade Practices Act1974 (Cth)

(and state/territory equivalents) the quiet achiever in franchise regulation

liability cannot be excludedbut increasingly innovative use of

contractual devices topreventmisleading conduct arising or to

preclude reliance cure not prevention

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Unconscionable conduct

A corporation must not, in trade or commerceengage inconduct that is in all the circumstances, unconscionable

s51AC(1) Trade Practices Act 1974 (Cth)

a more liberal unconscionability regime freed from the

limitations of the equitable doctrine unconscionability not defined but determined having regard

to the discretionary unconscionability factors.

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The discretionary unconscionability factors The relative strengths of the parties bargaining positions

Whether conditions not reasonably necessary for the protection of thelegitimate interests of the stronger party were imposed

Whether the weaker party was able to understand relevant documents

Whether undue influence or pressure, or any unfair tactics, were used

Whether and on what terms equivalent goods or services could have beenacquired from or supplied to other persons

Whether the stronger parties conduct was consistent with its conduct insimilar transactions

The requirements of any applicable industry code

The requirements of any other industry code if there was a reasonable beliefthat it would be complied with

Whether the stronger party unreasonably failed to advise of intended

conduct that could have a detrimental affect Whether there was a contractual right to vary unilaterally a term or condition

of the contract

The extent to which the stronger party was willing to negotiate contract terms

The extent to which the parties acted in good faith

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ACCC Si l N K d (F hi i ) Pt Ltd


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ACCC v Simply No Knead (Franchising) Pty Ltd

(2000) FCA 1365

The operation of the franchise depended on the supply of products from

the franchisor and group advertising for the franchise as a whole. Theallegation of unconscionable conduct was based on the following conduct:

Refusing to deliver franchise system products to franchisees.

Refusing to negotiate with franchisees and to discuss matters ofconcern to franchisees.

Deleting franchisees telephone numbers from Telstras 013Telephone Directory Assistance Service without consent or theknowledge of the franchisees.

Producing and distributing advertising and promotional materialwhich omitted the names of the franchisees and their franchisedbusinesses.

Selling and offering to sell its products in the territories of thefranchisees and in areas proximate to their territories; and

Refusing to provide current disclosure documents to franchisees inresponse to written requests

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Having regard to the discretionary unconscionability criteria

and the circumstances of the case, the franchisors behaviour

disclosed an overwhelming case of unreasonable, unfair,

bullying and thuggish behaviour in relation to each franchisee

that amounts to unconscionable conduct by SNK for thepurpose of s51AC

Sunberg J

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s51AC and the franchise sector

potential application to a range of circumstances at all stages in therelationship

little judicial guidance as few actions litigated

limited to extreme conduct which can be seen in accordance with the

ordinary concepts of mankind to be so against conscience that a court should

intervene good conscience does not require parties to contractual negotiations to

forfeit their advantages or neglect their own interest-that is the stuff of

ordinary commercial dealings

distinction between adopting an opportunistic approach to strike a hard

bargain and acting unconscionably

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Senate Standing Committee on Economics, The need, scope andcontent of a definition of unconscionable conduct for the purposes

of Part IVA Trade Practices Act 1974, December 2008

s51AC has fallen short of its legislative intent

addresses unconscionable conduct in theprocess of contractingrather than in the substantive bargain struck

regulator and courts have not pursued critical test cases lack of clarity and guidance

statutory definition not recommended

replacing unconscionable with unfair not recommended

target particular instances to clarify unconscionability

franchise sector should produce list of clear examples ofunconscionable conduct

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Consultation on Draft Provisions of Unfair

Contract Terms, May 2009

an unfair term of a standard form contract is void

power to prohibit terms considered to be unfair

a term is unfair if it

would cause significant imbalance in the parties rights andobligations

is not reasonably necessary to protect legitimate interests

considerations the court must take into account

specified B2B transactions including franchising included

negotiation removes a transaction from the scope ofthe provisions

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Good faith

implied in facton an ad hoc basis based on the presumedintention of the parties

implied in lawas legal incident of the relationship

wide, allbeit not unanimous, support

The precise boundaries of the standard have evaded the

grasp of precise judicial statementJobern [2007] FCA

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Meaning of good faith uncertain

the antithesis of bad faith

honesty

fairness

absence of opportunistic conduct/extraneous orulterior purposes

legitimate interests

reasonable expectations

community standards

reasonableness

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Limitations

inconsistent contract provisions

exclusion?

independent source of obligations?

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2008 Federal Opportunity not Opportunism report

notes concerns because of the continuing absence of an

efficient overarching standard of conduct for parties entering a

franchise agreement

recommendation for a new clause in FCC:

Franchisors, franchisees and prospective franchisees

shall act in good faith in relation to all aspects of the

franchise agreement

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The concept of good faith has gained traction as the solution to all realand imagined ills within the franchising sector. For those agitating for reformit has assumed symbolic significance and, if introduced, would be argued toaccommodate circumstances beyond any appropriate sphere of influence.Good faith is a seductive concept for franchisees and for the franchiseregulators but it will not be interpreted by the courts to provide theuniversal solvent the knights of good faith seek. The Aussie mantra of a fairgo is a beautiful thing but the operation of good faith will be interpretedmuch more narrowly. The perception that good faith is the universalsolution is both misleading and dangerous, but is given life by the equatingof good faith with ethics. A principle of good faith must presumably accord

with ethical standards and community values, but this is not, and should notbe, a concept the content of which is defined by them.

While an understanding of good faith as requiring a fair go would beenthusiastically received as a panacea for both the real and imagined ills ofthe sector, the reality of good faith as a legal concept is quite different. If

franchisor opportunism is a problem warranting legislative intervention thisshould be addressed by carefully crafted legislative responses rather than bydefaulting to an undefined and overarching standard of indeterminatescope and application.

Terry and Di Lernia, Franchising and the Quest for the Holy Grail: good faith or good intentions?2009 MelbourneUniversity Law Review, forthcoming

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NZ perceptions of Australian regime

FANZ

draconian

too wide ranging in application

too costly in terms of compliance

often ineffective in providing relevant protection to

franchisees and potential franchisees

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Minister Simon Power

numerous inquiries and reviews resulting in several

amendments creating onerous and complex disclosure requirements leading to increasing compliance costs for franchisors and

information overload for franchisees (para 24)

small number of franchising complaints to ACCC with concerns

often arising due to a failure to take proper precautions prior toentering the contract (ACCC) (para 25)

unrealistic expectations (DIISR)(para 26)

significant lobbying pressure to amend the Code (para 26)

regulatory uncertainty for franchisors (para 26)

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Other

the wording of the code has caused many

headaches

regulation encourages disputation

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draconian

Our members believe the Code has had a beneficial effect on the franchisingsector. There is overwhelming support for the existence of a Code and thefranchise sector does not seek to revise the Code from a policy perspective.

Franchise Council of Australia

At a time when most businesses are seeking a lessening of the regulatoryburden imposed by government, the franchising industry has been preparedto accept regulatory measures to protect the image and credibility of theindustry.

The Franchising Policy Council is of the view that the Code has been asuccessful initiative for small business in Australia. There is strong supportfrom most participants in the franchising industry for the mandatoryFranchising Code of Conduct

Franchise Policy Council

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too wide ranging in application

There is a significant amount of debate about how to define a franchise.Legal definitions of a franchise in countries that have introduced legislationhave been criticised for being too narrow, allowing people to structure theirbusiness to avoid regulation, or too wide, capturing businesses which are notfranchises. (para 5)

. a risk arises that any definition would either be too narrow, allowingpeople to structure their business so as to avoid legislative requirements, ortoo wide, capturing business structures that are not franchises. (para 34)

the definition used in Australia has been criticised as being too broad,capturing a wide range of business structures and creating uncertainty forother businesses who are unsure whether they have to comply with the Codeor not. (para 35)

20% of *US franchise lawyer Rupert Barkoffs] work as a franchisepractitioner is in advising clients on how to design their business model sothat it did not fall under the definition of franchise. (para 35)

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Code definition incorporates:

brand

system or marketing plan

payment

specific inclusions/exclusions

franchising v licensing/distributorships

ACCC v Kyloe [2007] FCA

clarify the relationships to be regulated and draft the definition

little scope for contracting around the definition

business dependency as a key element

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too costly in terms of compliance

regulation imposes an initial and ongoing financial andadministrative burden

FANZ Code disclosure obligations impose compliance costs

the Australian experience

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Regulation originally impacted on sector growth

Franchise systems Outlets

1998 693 38,500

1999 708 41,000

2002 700 44,000

2004 850 50,600

2006 960 61,850

2008 1,100 71,400

But:

exit/discouragement of inappropriate franchisors

encouragement of new franchisees

presumption of strong and sustained growth

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Often ineffective in terms of providing relevantprotection to franchisees and potential franchisees

The overwhelming success of franchising has attracted anumber of unscrupulous operators looking to capitalise on therapid growth in the sector, by deceiving potential small businessowners with offers of bogus or unworkable franchisingopportunities.

The ACCC enforcement actions have been successful indiscouraging these operators and it may be observed that the

introduction of the Code and its administration by the ACCC hasdissuaded a large number of illegitimate and dubious franchisesystems from operating in Australia

ACCC

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Onerous and complex disclosure requirements

increased compliance costs

information overload for franchisees

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Small number of franchising complaints

arising, primarily, from failure to take proper

precautions

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Franchising Complaints to ACCC

Franchising Council of Australia Legal Symposium

ACCC report card on franchising issues

John Martin, Commissioner

11 October 2007, Melbourne

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Breakdown of the ACCC investigatedfranchising

complaints outcomes 2006/2007

Resolution Number

No breach 11

Insufficient evidence 12

Referred to other agency 2

Guidance / information provided 24

Administrative resolution 1

No action 3

Active investigations 53

Total 106

ACCC

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Three main categories of franchising disputes

unconscionable conduct in business transactions; and

misleading and deceptive conduct/misrepresentations or

disputes around the terms of franchising agreement

These concerns generally fall into three broad categories:

scams, frauds or outright exploitation;

issues arising from structural market pressures; and/or

poor relationship management

ACCC

It is the ACCC experience that franchising complaints usuallyallege problems in at least one of two areas under the Trade

Practices Act 1974

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The most challenging complaints to deal with for the ACCC areallegations and disputes resulting from the remaining two

categories structuraland/orpoor relationship managementissues.

These generally manifest as persistent complaints ofunconscionable conduct, harassment and coercion and/ormisleading and deceptive conduct and present as a complexweb of interlinking accusations and claims, requiring timeconsuming investigations to untangle.

However, despite the painstaking analysis these matters rarelyuncover breaches of the Code or theAct.

ACCC

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unrealistic expectations

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constant review and regulatory uncertainty

Code will need to remain dynamic and subject to

review as the franchising sector evolves.

Opportunity not opportunism report

Franchising Code of Conduct Options Paper released

for industry consultation on 21 June 2009

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Opportunity not opportunism recommendations

Disclosure

Clear statement of liability/consequences to

franchisees in event of franchisor failure

process that applies in determining end of

term arrangements having due regard to the

potential transferability of equity in the value

of the business as a going concern

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Registration

Simple online registration system requiringfranchisors to lodge statement

Confirming nature and extent of franchise

network annually Providing guarantee of meeting obligations

under the Code and TPA

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Standards

Franchising parties to act in good faith in

relation to all aspects of a franchise

agreement

Government to explore avenues to better

balance rights and liabilities of franchisors and

franchisees in event of franchisor failure

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Enforcement

Pecuniary penalties for Code breaches

Pecuniary penalties for TPA unconscionability

and misleading conduct breaches

Broader ACCC powers to investigate when it

receives credible information indicating that a

franchising party may be engaging in conductcontrary to Code obligations

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The wording of the Australian Code has caused

many headaches

Code was drafted in haste and secrecy

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regulation encourages disputation

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The Australian perception of the Australian


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p p

experience

the Australian experience with regulation is overwhelmingly

positive:

wide sector acceptance discouragement of scam merchant franchisors greater confidence among prospective franchisees

greater certainty (eg termination/transfer) higher standards / best practice better and stronger relationships at all stages fewer disputes more effective dispute resolution management tool for franchisors

increased public confidence better relationships between franchise sector and media/ government focus for sector education, research, networking catalyst for strengthening role of FCA as peak sector body change in public perception/symbolism sector development

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Ironic that regulation imposed to discipline a sector has become a badgeof pride for it a recognition that franchising is important enough to

warrant its own regulatory regime

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The New Zealand Response

Overall, I do not believe that there is a need for the introduction

of franchise specific regulation at this time

Hon Simon Power,

11 June 2009

Franchisees are left to the dubious mercy of the classical bilateral

law of contractsHammond J in Dymocks

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franchising is not unique compared to other


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franchising is not unique compared to other

commercial relationships

difficult to argue that franchising is unique enough from

other types of businesses and contracts to necessitate

specific regulation (para 70)

FANZ favours the status quo as it does not think that there are

any particular features of franchise contractswhich

necessitate franchise specific regulation (para 18)

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But

Franchising can differ from other ways of doingbusiness as franchise contracts are both

relational (leaving many aspects unspecified) andstandard form (take it or leave it') contracts. Thismeans they must be flexible but also cannot benegotiated. This results in a large amount of

discretion being given to the franchisor, while thefranchisee has an increased amount ofuncertainty and risk. (para 4)

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There are several aspects of this way of doing business whichdiffer from some other standard contractual relationships:

It is an ongoing relationship, rather than a single buy and sell

transaction which may typically be covered by contract law; Issues of disagreement often cannot be usefully litigated as a court

case is likely to destroy an ongoing relationship, whatever theoutcome;

There are power imbalances in many franchise agreements and,while these exist in other contractual relationships, the fact that the

franchisor controls the use of the trademark and marketing systemgives rise to particular market power imbalances. This is because afranchisee's entire business may depend on the trademark andmarketing system;

As there are usually a number of franchisees, there can beproblems of equity of treatment and there can also be difficultieswhen a franchisor operates outlets which may compete withfranchised outlets; and

Obtaining information prior to an agreement can be difficult. (para28)

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Franchise contracts are to varying degrees both relational


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Franchise contracts are, to varying degrees, both relationaland standard form contracts, which creates some tension.Relational contracts create continuous and long-lastingrelationships. They are defined by features ofincompleteness and longevity, and must be flexible. Often ahigh level of discretion is accorded to the parties and thecontracts rely on reciprocity and trust developed over time.On the other hand, the individual terms of standard formcontracts are not generally negotiated they are presented

on a take it or leave it' basis. An imbalance of power resultsand the lack of negotiation can make it more difficult for theterms of the contract to be fully understood. Thecombination of these in a franchise contract gives a largeamount of discretion being given to the franchisor, while the

franchisee has an increased amount of uncertainty and risk.(para 29)

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little evidence of widespread problems

there is little evidence of widespread problems withinthe sector. (para 70)

FANZ favours the status quo as it does not think that thereare any widespread problems in the sector whichnecessitate franchise specific legislation. It does notbelieve that franchising should be singled out from otherforms of business. (para 18)

Contrast with Australia where a series of reports haveidentified problems within the sector

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1970s - entry of the US franchised fast food systems andadoption of the concept by local businesses

1980s - franchising emerges as a significant economicforce

1980s - bad practices, bad press and increasinggovernment scrutiny

1990s - increasing growth, bad practices and government intervention2000s - Australian franchising sector has the greatest

concentration of franchise systems per capitaamong the worlds major economies

- a mature, highly significant, diverse and dynamicsector

- includes virtually all consumer products and services- increasing influence in B2B and quasi-professionalservices

franchising development in Australia

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1976 Swanson Report

19 9 l


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1979 Blunt Report

1986 Franchise Agreements Bills Consultative Papers

1990 Beddall Report

1991 Franchising Task Force Report

1995 Gardini Report

1995 Better Business Conduct Discussion Paper

1996 Franchising Code Council Disputes Review

1997 Fair Trading Report

1997 New Deal: Fair Deal Statement

2006 Matthews Report (Review of the Disclosure

Provisions of the FCC)

2007 ACCC Report Card on Franchising Issues

2008 WA Report (Inquiry into the Operation of Franchise

Business in WA)

2008 SA Report (Franchises: Final Report)

2008 Federal Report ( Opportunity not Opportunism:

Improving conduct in Australian franchising)

Pre 1981 Regulation only under the general law


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85

1981 - 1987 Quasi-regulation under the prescribed

interest/managed investment scheme

provisions of the Corporations Law

1987 - 1993 Deregulation

1993 - 1996 Self-regulation under the voluntary Franchising

Code of Practice

1997 - 1998 Deregulation

1998 - current Regulation under the mandatory Franchising

Code of Conduct


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Unfair conduct by big business towards small business is [a] majorconcern [and] has been a matter of grave concern for many years.

Not only has such conduct the potential to impact heavily on the

economic health of the small business sector and on the allocation

of resources generally, it can also involve heavy social cost.

Australian Fair Trading Report 1997

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d


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current processes adequate

There is insufficient evidence to indicate that currentprocesses are inadequate to address any issues (para 70)

Underlying laws of general application

FANZ Code of Practice

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Underlying general laws

not as comprehensive as NZ

franchise business accounts for about 10-12% ofeconomic activity in NZ but franchisees represent

about 30% of misleading conduct actions under the

FTA

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FANZ Code of Practice

FANZ Code provides strong protection

400 franchise systems in NZ with 350 active (what

is an inactive system??)

FANZ membership represents 40-50% of franchise

systems limitation of voluntary sector self regulation

coverage

consequences

Australian experience

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ti i


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perception issues

the public's confidence in the franchising sector may have been

damaged following the cases of alleged fraud. Public confidence isimportant so that quality recruits are attracted to the sector,

allowing it to continue to grow and develop. (para 13)

introducing regulation to address perception issues was raised asa concern (para 16)

regulation is introduced to address information and power imbalanceissues

public confidence and perception issues are desirable byproducts

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addressing the information imbalance does not


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g

solve the problem

it is unclear that current arrangements which encourage duediligence are inadequate, or the extent to which the options

above would be effective in addressing information imbalances.

(para 46)

There is not strong evidence to suggest that options to address

information imbalances would result in better outcomes than

the existing processes to encourage due diligence. (para 54)

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Mandatory information disclosure may also be ineffective,

especially in targeting vulnerable groups who may notunderstand or use the information that they are given.

(para 49)

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Information disclosure only relates to the formation of the contractand not its performance, where issues would usually arise. (para

50)

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dd i t t l i b l t i ?


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addressing contractual power imbalance - not an issue?

A second group of options relates to addressing power imbalances and

the unilateral rights conferred upon franchisors under franchise

contracts. This could be done by mandating for certain contractual

terms to be included in franchise agreements, for example good faith'

bargaining or mandatory right of renewal. (para 55)

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addressing enhanced dispute resolution


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addressing enhanced dispute resolution

low cost dispute resolution is a generic issue for small business and there

does not appear to be anything specific about this to franchising. (para 61)

it is unclear that there is a problem [with relational disputes] with currentarrangements or the extent to which mandatory mediation would beeffective. (para 64)

Mediation is only successful if both parties cooperate and are willing towork towards a solution. Therefore, making mediation compulsory forfranchise disputes may not necessarily work and could provide anopportunity to further draw out the resolution of disputes. (para 67)

Some disputes would also not be suitable for mediation, such as thoserelating to trademarks. In some cases, parties may need interlocutory reliefto act urgently and mediation would not be appropriate. (para 67)

Thus there is not a strong case for making mediation mandatory forfranchising. (para 68)

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difficulties in regulating for better understanding,


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g g g

proper research and due diligence

Some problems appear to be the result of a lack of education

amongst franchisees and/or a failure to carry out appropriate due

diligence before entering into a franchise contract. It is difficult to

legislate to remedy this. (para 6)

While some see an information imbalance between franchisors and

franchisees, others see a lack of understanding among franchisees

and a willingness to enter contracts without doing the proper

research or due diligence which lead to disputes. It is difficult to

legislate to remedy this. (para 71)

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Franchiseprotection

Regulation

Specialistadvice

Disputeresolution

Due diligenceand research

Education andunderstanding


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many of the problems that can arise do not

appear to be exclusively problems with franchising,but issues which can occur in commercial

relationships generally. (para 42)

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risks and costs outweighs benefits


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risks and costs outweighs benefits

It is also likely that the risks and costs of regulation wouldoutweigh the possible benefits. These include the small size

of the sector in New Zealand which would suffer from

potential compliance costs and the difficulty in defining

franchise'. (para 72)

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the small size of the sector


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the dearth of red tape and low costs associated

with introducing franchising to NZ makes itattractive to franchisors, particularly those from

Australia

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regulation will not prevent Green Acres

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UK does not have regulation

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Regulation interferes with freedom of contract

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unclear that regulation would be the answer to


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any perceived problems. (para 71)

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Conclusion


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Conclusion Franchisees are damaged, and franchising is diminished, by the

inappropriate practices of those who trade off the reputation offranchising without the ability to deliver on the promise of franchising

Franchising is not an ordinary commercial contract

There are elements quite different to normal business developmentbecause of the control of the franchisor which can be an overridingrisk for other than purely business or commercial reasons

Regulation can address the additional franchise specific risks while

leaving the commercial risks to be handled by the parties

Regulation on its own can never be a complete answer

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The experience in Australia under the mandatory Franchising

Code of Conductprovides comfort to those franchising sectorsfacing regulation that appropriate and balanced regulation can

have a beneficial effect on the franchising sector and encourage

its orderly development for the benefit of all stakeholders.

Global Trends in Franchise Regulation

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