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Chapter 4
Pre-contractual arrangements
Definitional issues: coverage of the Franchising Code of Conduct
4.1
Clause 4 of the Franchising Code of Conduct (the Code) sets out the
meaning of a franchise agreement. Key elements of the definition are that a
franchise agreement is one in which:
(b) a person (the franchisor) grants to another person (the
franchisee) the right to carry on the business of offering, supplying or
distributing goods or services in Australia under a system or marketing plan
substantially determined, controlled or suggested by the franchisor or an
associate of the franchisor...
and:
(c) the operation of the business will be substantially or
materially associated with a trade mark, advertising or a commercial symbol:
(i) owned, used or licensed by the
franchisor or an associate of the franchisor; or
(ii) specified by the franchisor or
an associate of the franchisor; and
(d) under which, before starting business or continuing the
business, the franchisee must pay or agree to pay to the franchisor or an
associate of the franchisor an amount...[1]
4.2
Clause 4 also sets out a list of business relationships which do not
constitute a franchise agreement in and of themselves.[2]
4.3
The committee received some evidence indicating that there is a lack of
clarity in the current definition of franchising. Professor Warren Pengilley
cautioned:
What we have to do is work out what we are trying to regulate
because, if we do not get our definition right, we do not get the regulation
right...I suggest to you that the appropriate definition has to have in it the
concept of a long-term relationship or some more than passing relationship,
dependence on a trademark for the overall business of the franchisee, and a
power-dependence relationship...[3]
4.4
In his written submission to the committee, Professor Pengilley
suggested:
Many franchising arrangements are, in fact, normal commercial
arrangements not necessitating specific regulatory control and the cost of
complying with such control. It is only where there is "power
imbalance" that specific regulatory control is required. "Power
imbalance" may occur because of supply dependence, because of the power of
the franchisor in controlling the franchisee's business by use of a trade mark
or because of the public identification of the franchisor and the franchisee.[4]
4.5
Professor Andrew Terry agreed that the definition of franchising may be
too broad:
The problem with the definition is that it...has the potential to
catch arrangements that are not intended to be franchised—trademark licences
and...distribution agreements.[5]
4.6
Conversely, the committee also received evidence suggesting that the
definition of franchising may not currently be broad enough:
MTAA is concerned that the definition of 'franchise agreement'
in the Code is not sufficient to ensure that all franchise arrangements fall
within the scope of the Code...In particular, MTAA is concerned that it is
relatively easy for franchisors to structure their agreements in a manner which
enables them to avoid coverage under the Code even though those agreements are,
for all intents and purposes, franchise agreements.[6]
4.7
This concern was also raised by Mr Hank Spier:
The...definition of a Franchise for the purposes of the Code...is very
prescriptive and inflexible. Whilst prescription may appear to lead to certainty
it is also often a road map for avoidance.[7]
4.8
Mr Spier's submission went on to cite the example of agency
arrangements:
...where payment may be by way of commission and hence falls outside
the definition.[8]
4.9
In his submission to the inquiry, Mr Dick Adams MP pointed out the
similarities between franchises and the contractual arrangements of
commissioned agents:
...the commissioned agents are also involved in a contractual
arrangement between two independent parties with continuous obligations. And as
with the franchising code, these relational contracts are prone to adaptation
as time passes and circumstances change of have been misrepresented and there
is strong evidence that the Company exercises the control and takes a
commission on every aspect of the business, whether they have an interest in it
or not.[9]
4.10
Mr Adams' submission went on to outline the lack of recourse currently
available to parties to such agreements if they are treated unfairly and to
recommend:
That a review be undertaken by the Government of all these types
of contracts with a view to bring standard guidelines and responsibilities
across the nation.[10]
4.11
The committee received representations from some current participants in
the sector who feel that the Code is not the most appropriate regulation for
their industry. For example:
...the primary submission of the MTA is that the motor vehicle
industry in Australia is so significant that it warrants separate legislation
in much the same way that such legislation has been introduced for over five
decades in America and in most of the European Union countries.[11]
4.12
However, the Motor Traders Association of New South Wales (MTA) went on
to acknowledge that such a change would be 'a quantum leap' in Australian
legislation and, as such, is not an expected outcome of the current inquiry.
4.13
The Australian Marine Industries Federation Limited made a submission to
the inquiry that trade in motor boats should not be covered by the Code:
In order to generate an acceptable turnover, almost all
dealers/retailers sell a multitude of 'Motor Boat' brands and models all sold
from the same premises and sourced from various suppliers. This makes the
concept of franchising, where usually one major brand is promoted, impractical.[12]
4.14
7-Eleven advised the committee that the introduction of the Oilcode has
caused some confusion for their operations:
Our business involves the franchising of convenience stores that
are promoted and managed using our trade mark, "7-Eleven" and in
accordance with our System. We franchise convenience stores (Stores) some of
which sell fuel on our behalf. Of our 370 Stores, 187 do not sell fuel. Until
the Oilcode was enacted our franchising business was...regulated by the
Franchising Code only. Our business and the business of some of our Franchisees
who own non-fuel stores are regulated by the Franchising Code, those with Fuel
stores are regulated by the Oilcode and those with a mix of fuel and non-fuel
Stores, are regulated by a combination of the Oilcode or the Franchising Code,
dependent on the store.
4.15
7-Eleven indicated that their business has been adversely affected by
the additional regulatory complexity and increased administrative burden that
has followed the introduction of the Oilcode.
4.16
7-Eleven were not alone in noting the reach of the Oilcode with the
inquiry. But where 7-Eleven felt that the Oilcode was not suitable for
regulating some of their stores, Mr Ron Bowden of the Service Station
Association Ltd told the committee that the Oilcode does not cover enough
businesses:
The oil code is a fairly recent thing...Unfortunately, the code
covers only a very small area of the oil company or the master-servant
relationship in the oil industry. There are quite a few agreements in the
marketplace now that are not covered by the code. In fact, they are not covered
by anything other than just contract law.[13]
4.17
As acknowledged in the 7-Eleven submission, the Department of
Resources, Energy and Tourism is currently carrying out a review of the operation
of the Oilcode. The Oilcode only came into effect on 1 March 2007, so there has as yet been limited time to observe its impact in the marketplace.
Committee view
4.18
It is the committee's view that a broader review of the interaction
between the industry codes, and the respective definitions of arrangements that
fall within them, is beyond the role of the current inquiry. For the purposes
of the current inquiry, the committee is comfortable that there is sufficient
shared understanding of what constitutes a franchise agreement and is therefore
covered by the Code. As expressed by Professor Terry:
Everything that you and I and everybody in the community would
understand as a franchise is caught under the Franchising Code of Conduct.[14]
Pre-contractual education
4.19
For those business arrangements that are covered by the Code, the time during
which a prospective franchisee is considering entering into a franchise
agreement represents the best opportunity for both franchisee and franchisor to
make an accurate and informed assessment about whether this is the right
agreement for them.
4.20
From a franchisor's perspective, selection of appropriate franchisees is
important to maintaining brand performance and profitability.
4.21
From the franchisee's perspective, it is critical that they develop an
accurate understanding of what they are considering buying into. Often the
investment required by a franchisee is substantial, with many putting their
family home, their life savings and/or their superannuation investments at risk.
Franchisees need to fully appreciate not only the contract and conditions they
are being offered but the reality of the business they are taking on—including
the style and type of work, the hours required, the likely turnover, the challenges
of managing staff, and the need to conform with the franchise system and with
the franchisor's directions as specified in the franchise agreement, relevant
operations manuals and through other communications.
4.22
Franchisees also need to be alert to the real risk of business failure:
Entering into a commercial venture takes significant resources
and requires significant sacrifice of time and other personal values.
...
No amount of legislation or Codes will protect a small business
from failure. Indeed there is an entire sector that manages business failure.
Franchisees investing in a franchise system cannot firewall themselves against
failure. It is a false premise to think otherwise.[15]
4.23
There was widespread agreement amongst submitters that quality pre‑franchise
education is beneficial. As expressed by the Shopping Centre Council of
Australia (SCCA):
It is generally agreed that the best way to redress imbalances
in bargaining power is through education and accurate disclosure, since
inadequate information, knowledge and understanding are often key contributors
to the imbalance.
The SCCA certainly supports moves to provide and promote proper
education to prospective franchisees, especially in assisting with pre-business
feasibility planning and due diligence...Better educated and better organised
franchisees invariably run better businesses with resulting fewer disputes with
franchisors. Successful franchisees are generally good retailers and desirable
tenants.[16]
4.24
The Franchise Council of Australia (FCA) noted:
Improved pre-franchise education is critical so prospective
franchisees better understand what to expect, the risks involved, their rights
and their due diligence and other obligations.[17]
4.25
Some franchisees recognise that their pre-entry knowledge is limited:
One has to remember that franchising is marketed to the 'mums
and dads' of Australia, who generally...would not have had exposure to running a
business themselves and therefore have little business acumen to rely upon.[18]
4.26
Dr Elizabeth Spencer told the committee: 'I think it is important to
empower franchisees through education...',[19]
while Professor Andrew Terry took this a step further by suggesting that some
form of pre-franchise training be compulsory:
We need better education of franchisees, with franchisees taking
responsibility and exercising due diligence...Perhaps we should not let somebody
become a franchisee until they have at least ticked some boxes that they have
been to a course or they have been exposed to information.[20]
4.27
Professor Lorelle Frazer emphasised that both franchisee and franchisor
have a need in this regard, stating plainly: 'We need better pre-entry
education for both franchisees and franchisors'.[21]
Post Office Agents Association Limited (POAAL) also drew attention to the need
for franchisor education:
Just as many potential franchisees are not properly prepared for
the nature of responsibilities of a franchise business so it is that
franchisors are not necessarily prepared for the launch of their business as a
franchise model. Many seem to be unaware of the discipline and processes that
need to be in place for a franchise system to work effectively as a business.[22]
4.28
The committee received evidence of a range of educational material
available to prospective franchisees and franchisors. The Australian Competition
& Consumer Commission (ACCC) provides free information on its website which
is intended to promote compliance with the Code by both franchisees and
franchisors.[23]
The ACCC advised the committee:
To educate franchisors and franchisees about their rights and
obligations under the code and the Act, the ACCC has published a number of
educational materials to assist prospective franchisees, including:
- Franchising Code of Conduct compliance manual for franchisors
and master franchisees, book with CD
- Franchisee start-up, checklist
- Resolving franchising disputes, fact sheet
- Disclosure under the Franchising Code of Conduct, fact
sheet
- Being smart about your new franchise: checklist before signing
a lease agreement
- Being smart about your new franchise and your retail lease,
fact sheet
- Overview of the Franchising Code of Conduct, fact sheet.[24]
4.29
The ACCC website also provides links to the Department of Innovation,
Industry, Science and Research (DIISR), which has responsibility for assisting
the federal government in developing franchising policy, and to the Office of
the Mediation Adviser (OMA), which is responsible for facilitating mediation
arrangements set out in the Code.
4.30
In addition, the ACCC told the committee that it is developing an improved
communication strategy to advise franchisors and franchisees of their obligations
and protections under the Code, and that it is increasingly engaging with
advisers to ensure that legal, accounting and other business advice given to
prospective franchisees and franchisors is sound.[25]
4.31
The FCA sees an important role for industry bodies in providing
education to the franchising sector, indicating to the committee:
We have some ideas about how we could work with the government
to perhaps implement cost-effective educational campaigns, because at the end
of the day people are entering into a business decision.[26]
4.32
The FCA also noted that it is already taking action in this area:
We are working already on the education
angle as hard as we can. Last Friday we had our first ever pre-entry seminar.
We had a good turnout and got a very strong response. We did that in concert
with the ACCC and with Small Business Victoria. That is something that we will
take out probably to every state around the country.[27]
4.33
Furthermore, the FCA has sponsored a Franchise Academy that provides
training for franchisees and franchisors leading to nationally recognised
qualifications. Courses offered include a Diploma of Business (Franchising).[28]
4.34
There is also training and research relating to franchising taking place
in Australia's tertiary education sector. One example is the recently
established Asia‑Pacific Centre for Franchising Excellence at Griffith University,
and there are a number of other academics practising in this field.
4.35
The ACCC sounded a cautionary note about how much training can hope to
achieve and referred to the diversity of approaches needed to provide adequate
coverage:
We work with a variety of organisations. They range from
educational institutions, universities and even some TAFE-level courses. In the
past we have worked with bodies such as the Institute of Company Directors,
from very small micro firms, business enterprise centres and other business
advisers. It is a never-ending task, because you have a large number of new
firms always entering into the market, and you have also got a turnover of business
owners and managers as well. The level of knowledge out there is very hard to
maintain because it is not a fixed constant and you cannot improve it simply by
adding more to the level. In terms of the range, it is fairly extensive—print
media, educational, sometimes collaborative with other government agencies,
small business advisory centres and professional advisers, as well as the
general media. It is a fairly multipronged strategy.[29]
4.36
The committee recognises that pre-entry education alone cannot be the
panacea that prevents franchise failure. As expressed by Ms Jenny Buchan:
I have written and presented a paper recently on asymmetry of
information. In writing that paper I looked at each state and the federal
government’s information available to franchisees from the public domain. For
example, the federal government has a terrific online business information
service. I have looked at the Franchise Council of Australia’s education
package and nowhere, anywhere, without exception, does it mention that a
franchisor might fail. So the notion that a franchisor has got a pretty good
system that is pretty robust is perpetuated throughout the information that is
available to intending franchisees. Clearly that is incorrect so from that
perspective I would have to say that the education could be better and it could
be more comprehensive. However, even if you do educate people about some dire
consequences, once you have entered a relational contract as a franchisee,
regardless of the amount of information you have received you can sometimes
find yourself in a situation that no education in the world could have prepared
you for.[30]
4.37
The Australian Retailers Association (ARA) also acknowledged that the
picture painted in advance of franchise entry is sometimes too positive:
Perhaps franchisee education could further emphasis [sic] the
risk of failure, as sometimes the publicity of the success of franchising, and
even the increased security provided by the regulatory environment, makes
prospective franchisees too optimistic...[31]
4.38
The FCA, while generally supportive of the need for franchisees to
undertake pre-agreement education, cautioned that making such education
mandatory could act as a barrier to entry at a time when it is already becoming
difficult to secure good franchisees:
I love the idea of every potential franchisee having done a
course, as was talked about earlier. In a real world, franchise inquiry rates
are at a 15-year low at the moment. One of the biggest issues in this industry
is attracting new franchisees, because we are in a full employment economy, and
now we have got a double whammy where people cannot get access to finance. The
problem with having prescriptive prior training for potential franchisees is
that it will raise the bar to attracting new franchisees.[32]
Committee view
4.39
The committee is of the view that, though unbiased pre-agreement
education is extremely important (particularly for first-time franchisees), it
remains the responsibility of individuals to ensure they seek out information
and education before entering into a franchising relationship, not the
responsibility of government. Such education should not be mandated. As the SSCC
noted in its submission: 'Better education and better support services...are
non-legislative options'.[33]
4.40
However, there remains a clear and important role for the ACCC in making
accurate, unbiased and up-to-date educational material available to those who
choose to access it. Franchisee submissions to the inquiry revealed a degree of
uncertainty about where to source such information, indicating that there is
room for the ACCC to take a more proactive approach in its educative role.
Pre-contractual advice
4.41
It is even more critical for prospective franchisees to obtain sound
legal, accounting and other relevant business advice before entering into a
franchise agreement. In particular, for those franchisees who are new to the
small business sector, the committee considers it essential that they seek and
take qualified advice.
4.42
On this matter, the committee agrees with the view of the ACCC, who emphasised
the practical importance of obtaining such advice:
...we exhort and encourage franchisees to seek expert independent
advice. That means expert legal advice, expert accounting advice and sometimes
expert business management advice. So often what can happen is that a
franchisee will enter into a franchise arrangement and will do so by investing
a substantial sum of money with the thrill of getting a very substantial
return, but without having proper business management advice as to the economic
viability of the franchise, or indeed of the business expertise of the
franchisee, and therefore the ability of the franchisee in business management
terms to make the franchise work successfully.[34]
4.43
The committee received evidence that many franchisees do not seek, or do
not heed, such advice. An accredited mediator on the OMA panel indicated to the
committee:
During mediations it frequently becomes apparent that the
franchisee has declined to seek professional advice prior to entering into the Franchise
Agreement. This is most evident when the franchisee is...lacking relevant
business experience often of the most basic kind. In one example, the
franchisee had not inquired into the nature and likelihood of payment of debts
owing to the previous franchisee when taking over a franchise. In this case,
the franchisee had relied on those debts but they were in fact worthless.[35]
4.44
Participants in the franchising sector expressed some concerns about the
limited expertise and lack of liability of some consultants giving advice to
prospective franchisees. The ARA wrote in its submission: 'There is no
protection for franchisees and indeed franchisors from poor advice'.[36]
It followed this up in verbal evidence to the committee:
On the issue of consultants, both franchisor and franchisees
require advice and help to enter the franchise system. With franchisors the
consultant becomes a valuable support and their advice can mean the difference
between success or otherwise, yet there are no ethical caveats upon those that
can advise within the sector. Of course lawyers and some accountants have
ethical considerations, but the vast majority of consultants advising the
franchise sector are not so limited. Consultants write the franchise agreement
and, indeed, the important operations manual. If there is no correlation
between both documents then perhaps non-compliance will ultimately happen. The
fact that there are many anecdotes of franchise agreements being cut and
pasted, no matter the system, is a worry. In other words, advisers can be lazy
and just use one written agreement for one system and the same agreement for
another, when both systems are very different.
... ... ...
Another issue about these consultants includes those that are
marketing firms that sell on behalf of various brands. These consultants ask
for substantial deposits up front, and retain the moneys as a form of commission.
These salespeople are not required to meet standards, nor indeed the code, and
can virtually mislead at the expense of the franchisor, for it is the
franchisor that retains responsibility.[37]
4.45
Some submitters also pointed out that some legal and accounting
professionals who are approached for advice may lack sufficient
franchising-specific experience to give advice at the appropriate standard:
Your everyday solicitor/lawyer is not necessarily up to speed on
the franchising laws, problems and pitfalls...[38]
4.46
Some former franchisees who made submissions to the inquiry indicated
that, in hindsight, the advice they obtained was not of a sufficiently high standard:
I believe that most of the franchisees that I have spoken to
have gone and got advice. It was not necessarily the right advice because
franchising is a complex issue. I do not think that a lot of advisers
understand.[39]
Committee view
4.47
The committee is of the view that it is the responsibility of individual
franchisees, master franchisees and franchisors to seek and take competent
legal, accounting and other relevant business advice prior to entering a
franchise agreement. The committee considers that the stipulations already in
the Code—which require new franchisees to sign a statement that they have
either sought such advice or have chosen not to—are adequate, and that there is
no role for government is ensuring the accreditation or performance of advisers.[40]
However, industry moves to establish accreditation programs for franchising
advisers may be of benefit to the sector overall. Those entering the sector for
the first time should have particular regard to the franchising-specific
experience and knowledge of those from whom they seek advice.
Due diligence and disclosure
4.48
It is central to good franchising regulation that prospective
franchisees are provided with adequate information but franchisors are not
unduly burdened by onerous disclosure requirements:
When placing disclosure obligations on franchisors, it is
important that the Franchising Code strikes an appropriate balance between
ensuring that prospective franchisees are adequately informed about their
decision to enter a franchise agreement, while at the same time not placing an
unreasonable compliance burden on franchisors that will ultimately be to the
detriment of both franchisor and franchisee.[41]
4.49
The current disclosure requirements imposed by Part 2 of the Code are
described in Chapter 3 at paragraph 3.32. There are obligations on both parties
to the agreement: franchisors must provide certain information in a timely
fashion, and franchisees must acknowledge that they have received and
understood it (including that they have either received independent advice or
have chosen not to).
4.50
It is essential for franchisees to understand that disclosure
requirements under the Code are intended to assist, not replace, standard due
diligence processes. The obligation remains on a franchisee, and their advisers,
to adequately assess the business opportunity they are considering taking up. Equally,
there is an obligation on franchisors to provide accurate and full information
during disclosure.
4.51
Amendments to the Code that took effect on 1 March 2008 are intended to improve the future operation of the disclosure regime. In particular, new
requirements that franchisors disclose the contact details of former
franchisees for the last three financial years (except where a former
franchisee has requested in writing that their details not be disclosed) are
designed to assist prospective franchisees in identifying the reasons for
previous franchise agreements ending. One practice that this is intended to
guard against is franchise churning.[42]
4.52
It would be premature for the committee to judge the efficacy of the
March 2008 amendments to the Code in relation to disclosure. Nevertheless,
submissions to the committee have highlighted a range of continuing concerns
relating to the disclosure process. Some of these are discussed below.
Length of disclosure documentation
4.53
Many submitters have commented on the length of disclosure documents,
noting that the costs of seeking appropriate legal advice and the time required
to read them can be prohibitive:
Reduced, better focussed Disclosure Documents will also mean
less onerous compliance burdens for franchisors – particularly if it can end
the upward spiral in the size of disclosure documents. The FAA has the
objective of halving most current disclosure documents. A bonus will be the
greater likelihood that they are read and understood.[43]
4.54
The FCA points to the size of disclosure documents as an impediment to
franchisees obtaining appropriate pre-contractual advice:
Franchisees are not getting advice in accordance with the Code
requirements. Part of the problem relates to the cost of advice – with
disclosure materials regularly in excess of 100 pages, and sometimes much more,
it is difficult to keep costs down.[44]
4.55
Some franchisees admitted that they do not read the disclosure documents
they receive. For example:
The document is so thick and there is so much information there
that I honestly do not read it. I give it to my lawyer and say: ‘Here you go.
Just sign off on it.’ It has become crazy.[45]
4.56
The SCCA commented:
...disclosure documents that become too long and too comprehensive
can become intimidating for prospective franchisees and therefore be
counterproductive.[46]
4.57
7-Eleven agreed with this position:
7-Eleven is a strong advocate of clear and timely disclosure of
all issues in the Franchising process. However we have a real concern that
although the Franchising Code is well intentioned in relation to disclosure by
Franchisors, in practical terms, the quantity of documentation for Franchisees to
digest and receive advice on...goes beyond measures which assist the parties to
the franchise relationship. The disclosure requirements are so large that
Franchisees could not be expected to review all of the disclosed material
despite them needing to certify that they have...
The costs to the Franchisee of obtaining advice which must
involve a full review of the disclosure material, may act in practice as a restraint
on Franchisees obtaining...independent legal, accounting and/or business advice...[47]
Committee view
4.58
The committee agrees that better disclosure does not necessarily mean
more disclosure. A franchisor acting in good faith should provide a prospective
franchisee with the meaningful and truthful information they require to make a
sound business decision about whether to proceed with entering the agreement.
Disclosure documentation should be in line with Code requirements and should
focus on the provision of information which is difficult and/or expensive for
the franchisee to obtain through other means.
Accuracy and completeness of
disclosure
4.59
Many submitters have also expressed concern about the accuracy of
information contained in disclosure documents, indicating that the information
they received during disclosure was incomplete, or was inconsistent with
information they had access to after signing on as a franchisee. For instance,
one submitter wrote:
Had I known what my foray into the franchising world would
realise, I certainly would not have ventured into this so-called 'reputable and
proven' franchise system...All the due diligence in the world does little in
reality to prepare you for what you will be forced to endure once you are in
the System.[48]
4.60
Another claimed that his franchisor omitted mandatory disclosure
information and dismissed the breach as a technical oversight by a third party.[49]
Others referred to disclosure documents that were non-current or did not
reflect the actual contents of the agreement, or to the provision of inaccurate
or incomplete financial information.[50]
4.61
The common complaint relating to inaccurate or incomplete disclosure was
a perceived absence of legal accountability for franchisors that deliberately
mislead prospective franchisees during pre-agreement discussions. The legal
avenues available to franchisees and the ACCC in response to misleading
disclosure are examined in Chapter 9, in the context of the enforcement of the
Code and other relevant provisions of the Trade Practices Act 1974 (TPA).
Frequency of disclosure
4.62
The Code requires franchisors to maintain a current disclosure document,
ready to provide to prospective franchisees, or to existing franchisees who are
considering whether to renew or extend the term of a franchise agreement. A
franchisor must also honour a written request from a franchisee to provide a
current disclosure document, though such a request may only be made once in 12
months.[51]
4.63
Some franchisees indicated that more frequent or even continuous
disclosure would assist them in conducting their business and in being
appropriately aware of the true state of their franchisor's business:
It is recommended that franchisors must commit to a continuous
process of disclosure similar to the disciplines imposed on companies listed
with the Australian Stock Exchange.[52]
4.64
In particular, franchisees felt that a requirement for ongoing
disclosure would assist in alerting them to imminent franchisor failure:
A most significant omission is the lack of a requirement for a
company to change its disclosure document if it encounters difficulties such as
the appointment of an administrator or receiver during a current financial year.
The quality of reporting during the financial year is far less stringent than that
for public companies. Yet, franchisees, typically, have far more invested in
their businesses than average shareholders in their shares.[53]
4.65
Following the Code amendments that took effect on 1 March 2008, franchisors are now required to disclose 'any materially relevant facts' to franchisees
in writing within 14 days of becoming aware of such facts. The Code lists
matters deemed to be materially relevant, and these include any change in
majority ownership or control of the franchisor.[54]
Disclosure of leasing arrangements
4.66
The committee heard from franchisees and former franchisees who were
unaware of the head lease arrangements applying to their unit franchise when
they took up their agreement. Some suggested an additional disclosure
requirement for franchisors, obliging them to disclose to prospective
franchisees and franchisees the details of any head lease arrangements. This
was also a recommendation of the South Australian parliamentary inquiry.[55]
4.67
The Law Council of Australia disagreed with this position, in part on
the basis that franchisees can in many cases already obtain copies of
registered head leases through relevant Titles Offices in the states;
franchisees are not a party to the head lease; and it is a matter for the
landlord to determine whether they want to enter a direct tenancy relationship
with a franchisee in the event of franchisor default.[56]
Disclosure of rebates and similar financial
arrangements
4.68
An issue of concern has been the disclosure to franchisees of rebates or
similar financial arrangements that franchisors have in place with other
parties, including suppliers or in relation to head leases. The committee notes
that the recent changes to the Code now require franchisors to disclose whether
the franchisor 'will receive a rebate or other financial benefit from the
supply of goods or services to franchisees, including the name of the business
providing the rebate or financial benefit'.[57]
4.69
However, franchisors are not required to disclose the dollar amount
involved. The Law Council of Australia opposed any additional mandatory
requirement along these lines:
...a requirement to disclose the dollar amount of rebates may
prove practically difficult for a franchisor to comply with. The key material
information, being the price of the goods or services supplied, is already
required to be disclosed.[58]
Disclosure of franchisor
relationships with financial institutions
4.70
The committee also received numerous complaints from franchisees and
former franchisees about what they perceive to be close, and perhaps
inappropriate, relationships between franchisors and banks. For example, one
submission described a situation in which, having been refused a loan for a
franchise by their own bank due to having insufficient equity in their home, prospective
franchisees were referred to a second bank by the franchisor—a bank with whom
the franchisor had a 'special relationship':
This relationship needs to be examined and the bankers should be
charged for falsely approving loans that are not viable and will cause
destruction to their clients.[59]
4.71
Ms Sam Gow described the circumstances in which she obtained a loan as
follows:
My application was declined as I did not have the security nor
did I have any capital to start a business. I went back to the master
Franchisee and said "thanks but no thanks" as I can't get the finance.
He said here contact this person from a major bank, he will be able to help you
and needless to say the rest is history. Surprise Surprise I got the loan &
they even got my mum to go guarantor.[60]
4.72
Another franchisee put it this way:
Many franchisors have begun touting "relationships"
with banks that are designed to secure funds to purchase the franchise. However
in many cases the banks and their "franchise relationship" department
care little about the use of the money – they are just throwing the money at
the franchisee using their homes as collateral – not the franchise! When the
franchise fails, the banks just grab up the home if they can't get paid out.
This kind of lending short-circuits the usual fiduciary responsibility a bank
should have.[61]
Calls for the inclusion of risk
statements
4.73
Some submissions to the committee suggested that a risk statement should
form a compulsory part of disclosure or agreement documentation. In particular,
franchisees felt that it would be useful if the possibility and consequences of
franchisor failure were spelled out clearly in advance of them taking up a
franchise agreement:
I appreciate that any business venture presents risks including
the potential for total loss. However, franchising is very much presented as a
way of reducing this risk...
Potential franchisees should be made aware that the Franchisor
could fail, and what happens in the event of a Franchisor failure needs to be
defined in the Franchise Agreement...Failure of the Franchisor should not
automatically doom all the franchisees businesses to failure as well.[62]
4.74
Ms Jenny Buchan suggested:
The Code should include a requirement that franchisors disclose
the specific consequential contractual risk to the individual franchisee of the
franchisor being placed into administration or becoming insolvent (failing).
(See Matthews Report Recommendations 3 and 21). This should not be left to the
ACCC to do generically...
...
It's time for the sector to be realistic about franchisor
failure. Because the power in the drafting and the negotiation sits with the
franchisor, it is almost impossible for an otherwise keen franchisee to
insulate themselves from the consequences of franchisor failure ex ante.[63]
4.75
However, the Law Council of Australia stated:
It would be unduly onerous and probably impossible for a
franchisor to accurately outline the risks of a franchisee. The franchisee is
best placed to assess their own risks having regard to their own facts and
circumstances, and the information they receive...under the existing regime for
disclosure.[64]
4.76
The FCA acknowledged mismatched expectations between franchisees and
franchisors:
...it would appear some franchisees see franchising as a guarantee
of success and do not understand normal business risk. Some franchisors may (in
breach of current law, notably s52 TPA) oversell the business opportunity. The
ACCC needs to act here.[65]
4.77
However, the FCA rejected the call for franchisors to have to produce a
risk statement:
Franchisors should not have to produce a risk statement of all
risks relating to their individual franchise, as this would create major new
cost. This issue is much more efficiently addressed through education, including
through the publication by the ACCC of a booklet on franchise risk.[66]
Committee view
4.78
The committee is of the view that requiring a general and broad risk
statement as part of disclosure/pre-agreement materials is unnecessary. It is
the franchisee's responsibility to obtain and have regard to competent legal
and accounting advice that identifies relevant risks.
4.79
However, the committee is concerned about the specific implications that
franchisor failure can have for franchisees—for example, the potential in some
cases for franchisees to continue to be liable for paying a royalty stream to
administrators and/or to continue accepting stock already ordered from
suppliers under arrangements made by the former franchisor, even in
circumstances where the franchisee is effectively unable to continue trading.
Therefore, the committee believes the disclosure requirements in the Code
should be amended to require a franchisor to include a specific statement of
the liabilities and consequences for a franchisee in their network should the
franchisor fail.
Recommendation 1
4.80
The committee recommends that the Franchising Code of Conduct be amended
to require that disclosure documents include a clear statement by franchisors
of the liabilities and consequences applying to franchisees in the event of
franchisor failure.
Calls for registration or vetting
of disclosure documents and standard form contracts
4.81
The committee received evidence suggesting that centrally registering
disclosure documents and/or standard form contracts may improve compliance with
the Code and would also provide a useful research tool for those considering
entering a franchise agreement and for those monitoring the sector.
4.82
The ARA submitted:
A central body that registers disclosure documents will add credibility
to a franchisor. Thus the market can gain confidence in knowing that a checking
and validation system exists.[67]
4.83
The establishment of a mandatory federal registration system for
franchise disclosure documents was an explicit recommendation of the South
Australian parliamentary inquiry into franchising. The ACCC was suggested as
the appropriate body to maintain such a register and ensure that all documents
lodged are in compliance with the Code.[68]
4.84
An alternative suggestion received by the committee is that a franchise
section could be established within ASIC, giving it responsibility for:
...oversight of the franchising market in the same way it oversees
the equity and financial services markets.
...
Vetting by ASIC would, at a single stroke, cut back on thousands
of individual franchisees duplicating each other in consulting lawyers as to
whether or not a given franchise system meets the requirements of the
Franchising Code, the Trade Practices Act and that market buyers are fairly
informed.[69]
4.85
However, there were some concerns from franchisors about the
implications such a scheme would have for commercial-in-confidence information:
I believe there could well be some commercial material in the
agreements which we and other franchisors would not want publicly presented. I
thought I heard the proposition earlier today actually extending to disclosure
documents as well. I would have slightly heightened concern about some
commercial information in those documents...
...
Perhaps the information could be put up in a non-attributed way.
In other words, to say that X number of franchisors have the following
termination provisions and the others do not, or information of that nature
without actually saying which are which. At least people would then arguably
have the ability to say that the majority of them deal with the issue in this
way, why does mine not?[70]
4.86
Some submitters also expressed concern that registration of disclosure
documents, be it with the ACCC or another body, might somehow imply endorsement
of the system and discourage franchisees from seeking appropriate additional
advice.[71]
4.87
The International Franchise Association stated that it has seen little
benefit in registration systems operating in the United States:
...decades of practical experience with state franchise
registration and review requirements has shown that these regulations are
burdensome for franchise companies and state governments while conveying little
or no protection for franchisees. In fact, we are aware of no data in the United
States that shows that franchise investors in states with registration
requirements are more adequately protected from sales fraud than investors in
states without registration.[72]
Committee view
4.88
The committee considers that it is the proper role of legal advisers to
determine whether disclosure documents and agreements are in compliance with
the Code and other relevant regulation and legislation. Government resources
are better directed to educational and enforcement responsibilities.
4.89
However, the committee does see merit in a simple annual online
registration system for franchisors, requiring them to identify the nature and
size of their franchising system and, through the act of registering, to
provide a guarantee that they are operating their system in compliance with the
Franchising Code of Conduct. The ACCC could administer this system.
4.90
The features and benefits of such a system would include:
- For the first time, a central government body would have useful
data on how many franchise systems are operating in Australia each year.
- Franchisors would be required to confirm each year that they are
continuing to operate in compliance with the Code.
- Because it does not involve the actual lodgement of disclosure
documents or standard form contracts, businesses need not provide commercial-in-confidence
information as part of the registration process.
- It does not require a central agency to either store or vet
disclosure documents or standard form contracts.
Recommendation 2
4.91
The committee recommends that the government investigate the benefits of
developing a simple online registration system for Australian franchisors,
requiring them on an annual basis to lodge a statement confirming the nature
and extent of their franchising network and providing a guarantee that they are
meeting their obligations under the Franchising Code of Conduct and the Trade
Practices Act 1974.
Disclosure exemption for foreign
franchisors
4.92
The March 2008 changes to the Code removed a disclosure exemption that
formerly applied to foreign franchisors. Previously, if an operation based
outside Australia had only a single master franchisee in Australia, it was
sufficient for the master franchisee to disclose information to prospective
franchisees relating to their business dealings. Now the overseas-based
franchisor is also required to complete the disclosure requirements.
4.93
The committee received a submission from the International Franchise
Association pointing out that the removal of the foreign franchisor exemption
has created a substantial compliance burden on US franchisors operating in Australia
through a master franchisee:
In particular, this obligation is highly burdensome for
franchise systems that are not engaged in current sales activity in Australia.
In effect, the removal of the exemption requires many foreign franchise systems
to prepare annual disclosure documents for which there is simply no relevant
audience, and we strongly encourage you to consider restoring the exemption.[73]
4.94
Mr Robert Gardini told the committee that the removal of the foreign
franchisor disclosure exemption has created some uncertainty in the motor
trades industry:
Now this exemption has been removed there is growing uncertainty
around the obligation for foreign franchisors to provide disclosure documents
to potential dealers in addition to or jointly with the Australia master dealer...
It would therefore be my recommendation that the ambiguity in the code should
be addressed so that dealers, master franchisors in Australia and overseas
distributors can all be aware of the disclosure obligations relating to foreign
motor vehicle dealer distributors.[74]
Committee view
4.95
Much has been written and heard about the power imbalance in the
relationship between franchisor and franchisee. Once a franchise agreement has
been signed, the franchisee is bound to operate in accordance with the
franchisor's system, including changes to that system and any other
requirements that are made from time to time. However, at the pre‑contractual
stage, the power rests with the franchisee. As put by Mr Graeme Samuel of the
ACCC:
...we would want to stress to franchisees that their strongest
bargaining position exists up until they sign the franchise contract. Although
a lot is said about the disparate bargaining positions of a franchisor and a
franchisee, up until the franchising contract is signed they have a very strong
bargaining position. They have the money in their pocket. They have the pen in
their pocket, and they do not have to sign up to the franchising contract. The
moment the contract is signed by the franchisee, the bargaining position shifts
dramatically.[75]
4.96
The committee's view is that the pre-contractual period provides the key
opportunity for franchisees to protect themselves by ensuring that they are
appropriately educated—that is, that they fully understand the nature and
conditions of the business they are buying into—and to take heed of suitable
professional advice before signing an agreement. As noted by Professor Andrew Terry:
While it is appropriate that the special risks in franchising
due to the information and power imbalance be addressed (as indeed they have
been to a greater extent than anywhere else in the world under the FCC regime
supplemented by TPA misleading/unconscionable conduct provisions of general
application) ordinary commercial risks must remain with the parties.[76]
4.97
Nonetheless, it is incumbent upon franchisors to provide truthful and
meaningful information during the disclosure process, such that franchisees are
best placed to make an accurate risk assessment of the proposed business arrangement:
Clearly potential franchisees have responsibilities and must
accept certain levels of risk when investing in a franchise. However we don't
deserve to be scammed by unscrupulous operators; we deserve to have a level
playing field...The current system has been successful for those on both sides
that have good intentions and play by the rules. The system has however been
exploited and manipulated by a growing minority with only their own agendas and
profits at heart.[77]
4.98
The committee is particularly concerned that franchisors disclose
appropriately the liabilities and consequences for franchisees in the event of
franchise failure. It is this concern that underpins Recommendation 1 at
paragraph 4.80
4.99
Although the committee does not support the creation of a registration
system for disclosure documents or standard contracts, it does see value in
creating a central register of all franchisors operating in Australia.
Furthermore, it sees an opportunity for the act of registering to constitute a
guarantee from the franchisor that they are operating their franchise system in
compliance with the Franchising Code of Conduct and the TPA. This is the
rationale behind Recommendation 2 at paragraph 4.91.
4.100
It is the committee's view that some of the other concerns raised in
submissions relating to the pre-contractual period will be addressed by the
changes made to the disclosure provisions of the Code as of 1 March 2008. The committee recommends that the government monitor the disclosure issues
canvassed in this chapter and review the efficacy of the recent amendments in
mitigating these issues, with a view to making further amendments in the future
as necessary.
Recommendation 3
4.101
The committee recommends that the government review the efficacy of the 1 March 2008 amendments to the disclosure provisions of the Franchising Code of Conduct
within two years of them taking effect.
4.102
The committee makes an additional recommendation relating to the
disclosure of end of term arrangements in Chapter 6 at paragraph 6.91.
4.103
The committee addresses concerns about the enforcement of Code
requirements and relevant provisions of the TPA in Chapter 9.
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