Report on Fairness in Franchising

Franchises are often fraught with power imbalances, as the Franchisee carries most of the risk but lacks autonomy over the products sold or the business model. In recognition of this, on 14 March 2019 a Parliamentary Joint Committee released a number of recommendations intended to correct this imbalance. The Committee considered over 400 submissions from across the sector, and their report is an acknowledgement that the 2010 Franchising Code of Conduct currently in force is in need of a substantial overhaul. There are a total of 71 recommendations in the report, and so we will only focus on certain key areas in this article.

It is important to note that these are recommendations only – it remains to be seen whether the necessary legislative changes will be made to enhance the rights of Franchisees.

Disclosure

Often the previous financial success (or challenges) and legal obligations of a specific franchise store are not fully disclosed when entering into a Franchise, leading to Franchisees becoming trapped in poor performing outlets.

At times, this can lead to Franchisees making costly decisions based on information that is misleading or incomplete, resulting in them abandoning the unviable business after years of losses. Sometimes this is a deliberate strategy by the Franchisor called ‘churning’ – where poorly performing franchises are constantly resold so that the Franchisor obtains the benefit of upfront fees, despite the Franchisees’ constant losses. To counter this practice, the Committee has made the following recommendations in relation to disclosure:

• disclosure documents and the franchise agreement must be provided both electronically and in hardcopy form;
• the information statement provided to prospective Franchisees should be a separate document and subject to a cooling off period;
• if the prospective Franchisee is purchasing an established outlet, then the Franchisor must provide:
  • the previous two years’ worth of Business Activity Statements;
  • a profit and loss statement;
  • a statement of financial position; and
  • an assessment of labour costs for that franchise;
• if the outlet is a new store, then the above information must be provided from a comparable outlet;
• all financial information must be in or attached to the disclosure document;
• the Australian Competition and Consumer Commission will be empowered to better investigate and take action against Franchisors that engage in churning behavior;
• the creation of a public register for disclosure documents and franchise agreement templates, with civil penalties for failing to provide documents to the register;
• disclosure should be made to prospective Franchisees of the estimated personal workload required in order to operate the franchise.

Supplier Rebates and Third Line Forcing

In many franchising relationships, profits are made by the Franchisor not only from royalties but also from products they sell to the Franchisee. Those products can either be heavily marked up in price, or the Franchisor may receive a rebate for selling those products to the Franchisee. Due to the nature of the relationship, a monopoly is created by the Franchisor which allows them to profit whilst increasing the Franchisee’s fixed costs.

It has therefore been recommended by the Committee that the following changes be considered:

• identification of products which have a maximum resale cost below the cost price of the product paid by the Franchisee once all costs have been taken into account;
• disclosure of the margin between the cost price paid by the Franchisee and the maximum resale price of the top 5 performing products or services by volume of sales at that outlet (or a comparable outlet);
• the Australian Competition and Consumer Commission  to have the ability to enquire into Franchisors who exploitatively over-order goods and services, in order to generate revenue from royalties;
• disclosure to Franchisees of all rebates, commissions and other payments made to Franchisors in relation to the supply of goods and services;
• disclosure to Franchisees of an itemised breakdown of where the supplier rebate profits are spent;
• the Franchising Taskforce will be requested to investigate the potential for conflict of interest over third-line forcing and supplier rebates, in order to provide recommendations for future legislative changes.

Unfair Contract Terms

Often Franchisors have used their power over Franchisees to add and use unfair contract terms within franchise agreements. This can result in franchise agreements which provide few rights but plenty of obligations to Franchisees that are not reasonably necessary for the protection of the Franchisor. Unfortunately though, the current definition of a small business for the purposes of the unfair contract term regime may exclude certain Franchisees from being able to rely upon it.

To create a better balance of rights and obligations in franchising agreements, the Committee has recommended the following in relation to terms within franchising agreements:

• the Franchising Taskforce to consider whether or not civil penalties should apply when a contract which contains unfair contract terms is provided to a small business or Franchisee;
• increase the level of resources to the Australian Competition and Consumer Commission so that they can respond to all complaints about unfair contract terms;
• changes to the legislation to be considered so that the unfair contract terms regime cannot be excluded in any franchise agreement;
• the Franchising Taskforce to consider how to deal with the issue of unfair contract terms in perpetual franchise agreements;
• the Franchising Code of Conduct to be amended so that any variation of a franchising agreement (including of manuals or policies) must be agreed to by the majority of Franchisees within that franchise system.

This report has acknowledged the power imbalance which favours Franchisors and it is promising to see such a wide variety of recommendations aimed at addressing it. However, we do maintain a healthy skepticism until these recommendations start to be implemented.

Should you require any assistance regarding franchising agreements, including dispute resolution and agreement reviews, our highly experienced lawyers are available to assist you.

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