02/04/2019

Summary – what you need to know

On 22 March 2018, the Senate referred an inquiry into the operation and effectiveness of the Franchising Code of Conduct (Franchising Code) to the Parliamentary Joint Committee on Corporations and Financial Services (Committee).  The Committee released its Fairness in Franchising report (Report) on 14 March 2019. 

The Report found systemic problems in franchising arrangements, including exploitation in certain franchise systems, and, as a result, made a raft of recommendations that would involve significant changes to the Franchising Code and the power and responsibilities of the ACCC.  These recommendations aim to mitigate the worst impacts of the power imbalance between franchisors and franchisees.  If implemented, these recommendations would have very real practical impacts on the way franchisors engage with franchisees.  

Going forward franchisors can expect:

  • increased regulatory scrutiny of franchise arrangements and a greater likelihood of enforcement action being taken by the ACCC, and indeed the potential for action from other regulators such as ASIC and the ATO;
  • potential claims for damages by franchisees in respect of unfair treatment by franchisors; and
  • a need for franchisors to review and amend franchising agreements and their disclosure statements and supporting documentation, such as operations manuals, to ensure their compliance with any resulting amendments to franchising regulations.

Context – “Franchising is big business in Australia

The Report notes that:

  • franchising was estimated to have contributed approximately 9% of Australia’s GDP in 2016, so it is “big business in Australia”;
  • the traditional view of franchising, and one that appears to exist in all successful franchise operations, is that franchising is a mutually beneficial relationship between franchisor and franchisee where franchisees have access to leadership, training and support within a proven business system, while franchisors can grow their business and develop their brand with the support of a network of franchisees;
  • despite the above, franchising arrangements commonly involve a power imbalance between the franchisor and franchisee , characterised by a combination of:

- the franchisor’s contractual power;

- the degree of operational control the franchisor has over the business; and 

information asymmetry between franchisee and franchisor (for example, in relation to earning potential of a particular franchise).

In a scathing assessment, the Committee found that:

"the current regulatory framework has manifestly failed to deter systemic poor conduct and exploitative behaviour and has entrenched the power imbalance."

The Committee also referred to the following themes which recurred throughout the inquiry:

  • transparency and accountability;
  • fairness and protection; and
  • education and awareness.

What recommendations have been made?

In this context, the Committee has taken a “two-pronged” approach to improving regulation of franchising which involves:

  • a number of significant amendments to the Franchising Code; and 
  • greater enforcement powers for the ACCC. 

The Report makes a total of 71 recommendations.  Below we highlight 10.

Topic Recommendation
Creation of a franchising taskforce The Committee has recommended that the Australian Government establish an inter-agency franchising taskforce to examine the feasibility and approach to implementation of many of the recommendations in the Report.  This taskforce is likely to include representatives from the Department of the Treasury, the Department of Jobs and Small Business, and in some instances, the ACCC. Accordingly, it is likely to be some time before any amendments to the Code recommended by the taskforce would take effect.
Civil penalties for breaches of the Franchising Code

Currently, only some provisions of the Franchising Code attract a civil penalty if breached. The Committee recommends amending the Code to make penalties available for breaches of all provisions, and increasing penalties under the Code to reflect the penalties available under the Australian Consumer Law.1

Unfair contract terms The Committee recommends making the inclusion of unfair terms in franchise agreements with small business customers illegal.  Under the recommendation, including an unfair contract term in these kinds of agreements would attract a civil pecuniary penalty or infringement notice.2
Churning and burning The Committee raised concerns about “churning and burning” of franchises.  “Burning” refers to the continual opening of new outlets to profit from upfront fees, but doing so in knowledge that opening new sites would leave existing outlets to struggle and close.  “Churning” is the repeated sale of a failed franchise at a single site to a new franchisee. 
The Committee recommended that the ACCC be given powers to intervene to prevent franchisors from marketing and selling such franchises during the course of investigations.3
Supply arrangements and rebates 

The Committee has recommended mandatory disclosure of all supplier rebates, commissions and other payments franchisors receive from the supply of goods or services to franchisees, both as a percentage of the purchase price on the transaction, and of what proportion of the rebate will be retained by the franchisor.4 

Franchisors would also be required to disclose pricing and margin information where they had required franchisees to sell items below cost in the two year period prior to the franchisee entering into the franchise.5

More broadly, the Committee recommended an investigation into conflicts of interest associated with supplier rebates and third line forcing (requiring franchisees to obtain goods or services from a third party), with a view to possible regulatory change to address these conflicts.6  

Increased disclosure of financial information

The Franchising Code currently allows franchisors to opt out of providing prospective franchisees with earnings information or financial statements for existing businesses.7   

To help franchisees assess the viability of a franchise, the Report recommends that anyone selling a franchise be required to provide two years’ of certain earnings information in disclosure documents.8 

Unilateral variations to terms The Committee recommended the Franchising Taskforce consider whether the Franchising Code should include restrictions on franchisors’ abilities to unilaterally or retrospectively vary terms and conditions in franchise agreements or subsidiary agreements, such as operations manuals.9  These restrictions may include such amendments only being able to be made with the agreement of a majority of franchisees within the same franchise system.
Exit rights for franchisees The Committee acknowledged that termination rights in franchising are heavily weighted in the franchisor’s favour.  Accordingly, the Report recommended the inclusion in the Franchising Code of a no fault termination provision for franchisee-triggered exit from franchise agreements in certain circumstances (such as business failure).  This provision would prevent the franchisor from pursuing performance of the agreement (such as ongoing royalty payments) other than normal short-term liabilities associated with winding up a business.10
Arbitration as a dispute resolution mechanism The Committee heard submissions regarding the ineffectiveness of the mediation process under the Franchising Code, and the only current alternative being institution court action which is often prohibitively expensive for franchisees.  Accordingly, the Committee recommended the inclusion of binding arbitration in the Franchising Code’s dispute resolution process.11
Collective bargaining The Committee accepted the ACCC’s proposal to provide legal protection for franchisees to collectively bargain with their franchisors on matters such as franchise business models, dispute resolution, and information sharing.12
Franchisee representation  The Committee stated that many of the problems considered in the Report, including the unbalanced regulatory framework, were at least partially a result of a lack of effective representation of franchisee views. 
The Committee recommended that franchisees establish a strong national association and that, until this occurs, the Franchising Taskforce consider how consultation processes associated with franchising policy regulation and legislation can achieve appropriate input from franchisees.13

 

Where to from here?

Businesses should prepare themselves for the following possible consequences coming out of this report. 

Increased scrutiny and enforcement action 

The Committee has stated that it “expects the ACCC to undertake a series of investigations to root out misconduct and exploitative behaviour in the franchise sector”.  While there are specific recommendations that the ACCC, ASIC and the ATO conduct investigations into the operations of Retail Food Group, the Committee has generally advocated for a more proactive approach to investigations and enforcement action by the regulators.  

This, coupled with the Committee’s call to the Government to adequately resource the ACCC to investigate complaints about unfair contract terms, means franchisors should be prepared for greater oversight of their franchise systems and that there is a greater likelihood of enforcement action being taken, particularly in relation to persistent or systemic breaches or instances of exploitative behaviour by franchisors.

Review of existing franchise agreements

Franchisors will need to review their franchise agreements, disclosure documents and supporting operational material, and potentially existing franchise agreements, for compliance with any amendments to the Franchising Code.  
The Report contemplates a suite of changes to the Franchising Code.  Usually, changes to the law will not operate retrospectively.  However, it is possible that any changes made as a result of the Report would give businesses a “window” in which to review their existing arrangements and bring them up to speed with the amendments.  This is the approach we have seen in the legislation to repeal the intellectual property exemption in the CCA, discussed in a previous G+T insight, and given the long term nature of franchise agreements and the political considerations involved, there is a chance that the Government would take a similar approach here.

Class actions and claims for damages

Although no pecuniary penalties are currently available under the unfair contract terms regime, the ACL gives a right to damages for persons who have suffered loss or damage because of a contravention of these provisions.  Franchisees may bring actions against franchisors, either through class actions or separately, to recover damages for losses incurred by reason of unfair contract terms, or for example, due to misleading representations that induced them to enter franchise agreements.


Recommendation 16.1

Recommendation 9.1

Recommendation 4.1.

Recommendations 8.1 and 8.2.

Recommendation 7.1.

Recommendation 8.3.

See Item 20.3 of Annexure 1 to the Code.

Recommendation 6.3.  The earnings information franchisors are required to provide includes the prior two years’ Business Activity Statements, a profit and loss (income) statement and balance sheets (statement of financial position) and an assessment of labour costs for that particular franchise business. 

Recommendations 16.2, 9.7 and 9.8.

10 Recommendation 11.1

11 Recommendation 15.2

12 Recommendation 14.1.

13 Recommendation 5.1.

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