Australia: Franchising inquiry report released

The much anticipated parliamentary report into the franchising sector was released on March 14, 2019. The report is the culmination of more than a year of written submissions, public hearings and intense media coverage of the inquiry and associated scandals.

The report makes several stark observations on the sufficiency of the current regulatory regime, and how current laws have failed to curtail unscrupulous activity by some franchisors. The report points to major structural and cultural issues in the sector, and contends that substantive reform is required to alleviate industry issues which are painted as systemic and pervasive. Whilst the majority of franchise systems would not identify with this characterisation of our sector, one thing is clear, the whole sector has been tarnished by the revelations in the inquiry and the franchise community needs to be part of the solution.

It is clear that the committee wants the ACCC to take a broader role in franchise sector compliance monitoring and complaints handling. In order to do so, the ACCC may require an increase in resources, given the scale of the franchising sector. No well-intentioned franchisor should hold fears over a broadening of the ACCC's role, as this will ensure bad behaviour is investigated and punished appropriately, and complaints are appropriately investigated. These are keys to restoring public confidence in the franchise sector.

The report is comprehensive, at 369 pages, and contains more than 70 recommendations. The executive summary of the report, and the media commentary surrounding its release, foreshadow major structural reform of the sector. However, on reading the recommendations carefully, many are suggestive rather than conclusive, and frequently defer matters for further and more thorough consideration by the proposed Interdepartmental Taskforce. This seems sensible given so much of the evidence to the Franchising Inquiry was anecdotal, and further considered input is appropriate to ensure quality outcomes, avoid unintended consequences and ensure compliance costs are not excessive.

Many of the recommendations are not surprising given the gravity of the issues ventilated during the inquiry process. Some of the committee's policy suggestions are sensible legislative reforms that essentially give effect to current practice by professional franchise systems and address concerns about any imbalance in the power relationship. Other more confronting recommendations will be debated and refined over time before being implemented, so franchisors will have the opportunity to adjust to any new challenges presented by the eventual reforms. The report foreshadows additional compliance challenges ahead, but no existential threat to quality franchisors with fair and professional current practices.

The Small Business Minister, Michaelia Cash, will now consider the recommendations contained in the report and the Department of Treasury will likely push towards implementing some of the proposed initiatives, starting with the formation of the Franchising Taskforce. At this stage, the report is simply a set of recommendations which ultimately need to be worked through the legislative process.

The looming federal election may impede the momentum for change, as the Government and Opposition will be occupied with other matters. We therefore may not see definitive action on these policy recommendations for some time. However, it is vital that all franchise systems review the report carefully and take heed of some of the impending changes to our sector. Franchisors would be well served by taking on some of the sensible recommendations voluntarily, in the pursuit and best practice, and in anticipation of the likely reforms.

Amongst the key recommendations are the following

  • Franchising Taskforce: The report call on the Government to establish an inter-agency "Franchising Taskforce" to examine the feasibility and implementation of many of the committee's recommendations. The taskforce would include representatives from the Department of the Treasury, the Department of Jobs and Small Business and where appropriate the ACCC. Given many of the recommendations defer to the Franchising Taskforce to develop solutions to identified issues, there is some way to go before the sector will have a full picture of the likely legislative reforms.
  • Franchisee association: The report calls for franchisees to bind together to develop a strong national association, to counter the alleged influence of franchisors and their representatives. However, the franchise sector sits across hundreds of different industries, and the 80,000 franchisees vary significantly in nature, size and sophistication. There would be inherent challenges in attempting to bring together appropriate representatives of the 80,000 franchisees of divergent interests. There is a clear desire for Government to give a greater voice to franchisees in the regulatory conversation. The Franchise Council's newly established Franchisee Advisory Committee is likely to be seen as a constructive and practical step to fill the void.
  • Marketing funds: The committee recommends greater transparency and accountability with regard to marketing funds. Presently the Code requires annual reporting – the committee recommends extending this to quarterly reporting. This would represent a significant increase in the administrative burden of operating a marketing fund. The report proposes civil penalties for failing to adhere to this requirement, so franchisors would need to be far more attentive to the ongoing management of their marketing funds.
  • Disclosure of financial information: The Report recommends extensive additional disclosure of financial information in the context of sales of existing franchised businesses, including 2 years' Business Activity Statements. For greenfield sites such information must be provided for a comparable franchise. Specific assurances are required that earnings information is accurate, and such information must be provided as part of the disclosure document. Although the detail of these requirements will need adjustment, these recommendations address central concerns and are likely to be implemented unless the relevant Minister rejects the Report in its entirety. This requirement would need to dovetail into other existing legislation, such as State laws governing sales of small businesses, and may need some tailoring to deal with the breadth of franchising models. This requirement would increase the risk to franchisors in granting franchises and overseeing transfers, as the franchisor would be held directly liable for representing the likely profitability of the franchise opportunity. This would likely lead to a higher rate of claims against franchisors.
  • Registration: The report calls on the Franchising Taskforce to explore options for compulsory registration of franchise systems, including a requirement to lodge key documents on an annual basis. The ACCC has been flagged as the possible custodian of the registry. The Australian Franchise Registry operated by FRANdata already exists on a voluntary basis, so this may be a model for the Franchising Taskforce to consider. The Franchise Council of Australia intends to make registration a mandatory requirement of FCA membership, and an industry solution is likely to be preferred by most franchisors to a Government administered framework. If franchisors embrace the industry initiative there would seem little point in the Government overriding or replacing it.
  • Rebates: The report recommends greater transparency regarding supply arrangements which yield rebates for the franchisor, in the form of mandatory disclosure in percentage terms of rebates, commissions and other payments received by the franchisor for supplies to franchisees. In the past, franchisors have been required to disclose the identity of suppliers providing rebates. However, opening the books on the underlying rebate arrangements will be uncomfortable for many franchisors. There would be a genuine concern around the disclosure of commercial in confidence information to competitors if this recommendation becomes law.
  • Supply chain: The report proposes that the Franchising Taskforce explore requiring a franchisor to disclose deep and complex data and analysis regarding current and historical supply arrangements. A core concern for the committee is to prevent price-gouging by franchisors, given that many franchisors before the inquiry were accused of forcing franchisees to purchase goods at prices higher than were otherwise available on the open market. The proposed requirement would be administratively onerous on franchisors and likely so complex that franchisees would not benefit from the additional information. There are many good reasons for franchisors to control the supply chain. Anecdotal evidence comparing prices between an item delivered to a franchise store through a reliable and consistent supply chain against a special price at a supermarket is not particularly helpful. If anything, the proposed disclosure regime would likely give franchisees a misconception that they are being gouged by the franchisor, by not taking into account factors other than gross price.
  • Whistleblower protections: The inquiry recommends extending existing Whistleblower Protections to protect franchisees reporting on breaches of the Franchising Code and Oil Code. It would seem hard for franchisors to reasonably resist this move, as it is essentially an extension of a regime which most fair-minded people would expect to apply to a franchise relationship.
  • Unfair contract terms laws: The report recommendations echo the current proposal by the ACCC to extend the UCT regime to make unfair terms illegal and subject to civil penalties. They further suggest that all franchise agreements should be deemed to be standard form small business contracts for the purpose of the legislation. The recommendation seeks to impose a greater incentive for franchisors to revisit and amend their agreements. One of the issues we see is that franchise agreements may not neatly fit within the UCT legislation, given that there is comprehensive disclosure, 14 day waiting periods, 7 day cooling off periods and legal and business advice requirements that arguably mitigate against a franchise agreement being a true "standard form" agreement provided on a "take it or leave it" basis. Unilateral variation of agreements. The Report proposes various options, including that agreements cannot be amended without consent of a majority of franchisees. A final landing point is likely to be some form of agreement that unilateral variations are only possible in defined circumstances, in relation to subsidiary matters as opposed to fees or commercial terms or with majority franchisee approval. Cooling off. Changes are proposed to cooling off requirements that seem difficult to understand, and seem impractical. Cooling off is also proposed to apply to transfers and renewals, which seems unworkable and likely to create significant unintended consequences.
  • Termination and goodwill: The committee recommends allowing franchisees to terminate their franchise agreements in certain circumstances. Although there could be some support for limited rights of termination, the breadth of proposed circumstances (including circumstances such as hardship) will not secure broad industry support. The Report also recommends curtailing franchisor's rights of immediate termination in special circumstances such as fraud and danger to public health and safety, and inserting a 7 day period before immediate termination can be activated, during which a dispute notice can be served by a franchisee and termination thereby suspended. The Taskforce is also charged with giving further consideration to franchisee goodwill, and how goodwill might be calculated in certain different circumstances including when a franchisee has lost the right to occupy the premises. Significant additional work would appear to be needed to achieve industry consensus on how these provisions might sensibly operate.
  • Collective bargaining: The committee recommends that the Government declare a class exemption to make it lawful for franchisees to collectively bargain with their franchisor. The opportunity to collectively bargain already exists in practice, as franchisee are either not competitors or can apply easily for an exemption. This reform would not have a significant impact on the existing relationship between franchisors and their franchisees.
  • Arbitration: The report recommends mandatory arbitration if mediation is unsuccessful. The committee proffers that arbitration is cheaper and more flexible than pursuing court action, which is not necessarily the case in our experience. Arbitration can also be less predictable and can result in perverse outcomes if the arbitrator is inexperienced in the subject matter. Then of course, if the franchisor is unhappy with the result at arbitration, the franchisor will be at liberty to pursue an appeal through the court system, which would involve the franchisee in more costs. There would be a significant administrative cost to set up the infrastructure for an arbitration regime, assuming there would be some oversight by the Office of the Franchising Mediation Adviser or the Small Business and Family Enterprise Ombudsman.
  • Collective disputes: The report goes on to suggest empowering groups of franchisees to initiate collective mediation and arbitration. In our experience, group mediations rarely produce constructive outcomes, as they are used by vocal franchisees to advance their own grievances. This would present a whole new dynamic for franchise disputes, where groups of franchisees could cripple a franchisor with repetitive group disputation which undermine the franchisors efforts to run a mutually profitable business model.
  • Alignment of codes: The report recommends aligning the Franchising Code and the Oil Code, which have diverged somewhat over the years. This may result in the loss of some unique features of the Oil Code which provide fuel franchisors additional rights of termination, amongst other things.
  • Civil Penalties: Presently, civil penalties only apply to certain key provisions of the Franchising Code. The report suggests applying civil penalties to every clause of the Code. In our view, not all provisions are appropriate for civil penalties, and the current penalty regimes is correctly tailored. If a blanket approach is taken to civil penalties, there is the prospect of significant fines even for fairly trivial breaches of clauses in the Code which were not drafted with strict liability in mind.
  • Churning: The report recommends that the ACCC be given power to identify and act on instances of systemic churning and burning. If a franchisor is engaged in such a practice, the current law already permits the ACCC to pursue a franchisor for unconscionable conduct, so ultimately this recommendation may not change the current legal position, unless extensive additional powers of intervention are implemented.
  • Education and advice: The report recommends that the ACCC develop a website for franchisees, akin to ASIC's MoneySmart Service, and recommends that franchisors be required to provide a copy of the ACCC's Franchisee Manual to all prospective franchisees as part of disclosure. This recommendation has some attractive elements, but is likely to require further refinement by the Taskforce.
  • Retail lease arrangements: The committee recommends that the Franchising Taskforce consider various matters, particularly in relation to the clarity, transparency and timeliness of the disclosure of retail lease agreements to the franchisee. Franchisors are generally very vigilant around disclosure of retail tenancy information to franchisees, as occupancy arrangements are a major factor in the success of the franchised business. However, franchisor and franchisee complaints to the Inquiry concerning the anti-competitive conduct at the hands of major shopping centres have been ignored.

A comprehensive analysis of the report, and the implications for franchise systems, will be provided at our forthcoming Franchising Intensives.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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