Australia: In-depth Report On The Franchising Code Of Conduct: ´Opportunity Not Opportunism: Improving Conduct In Australian Franchising´

On 1 December 2008, the Parliamentary Joint Committee on Corporations and Financial Services (Committee) reported on its inquiry into the Franchising Code of Conduct (Code) which it conducted earlier in 2008. Unlike the 2006 'Matthews Review', which focused on franchisor disclosure, the report represents a detailed review of the Code in the context of the franchising industry generally.

The Committee made 11 recommendations in its report, considerably less than those made in the reports documenting the West Australian and South Australian inquiries into franchising. Nonetheless, it appears that the Committee has taken a somewhat paternalistic approach toward franchisees. If the recommendations are adopted, they will impose greater financial, administrative and disclosure obligations on franchisors.

An overview of the recommendations follows.

INCREASED FRANCHISOR DISCLOSURE

Recommendation 1: that the Code 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

Committee's reasoning

The Committee considered a number of issues in relation to pre-contractual arrangements between franchisors and franchisees. These included education, advice and due diligence. However, the Committee ultimately determined that these were the responsibility of the franchisee.

The Committee also did not consider that general or broad risk statements of entering franchise agreements was required for franchisees. In its opinion, it is the franchisee's responsibility to obtain competent legal and accounting advice and consider the risks identified by it. However, given the recent failures in the Australian franchising industry and franchisees' current limited rights, the Committee was concerned about the specific implications of franchise failure for franchisees. The Committee cited examples of franchisees having possible continuing obligations of paying royalties to administrators and accepting stock from third party suppliers.

What the recommendation may mean

If accepted, disclosure documents would need to include a 'clear statement' of what consequences franchisor failure would have on franchisees. At this stage, it is not clear what 'failure' encapsulates, for example, whether it would include a franchisor's termination of their master licence. Further, the level of detail required by the statement, and the consequence of an original statement being inaccurate in a later case of failure, are still uncertain. Presumably the statement would need to include a potentially exhaustive list of consequences for the franchisee, examples of which were given by the Committee. Unfortunately for franchisors, this would no doubt require both legal and possibly accounting input from their advisers.

The Committee recommendation on this issue appears to be inconsistent with its recognition that general or broad risk statements were not required because of each franchisee's responsibility to obtain legal and accounting advice. In light of this view, we would have thought that the consequences of failure of a franchisor should not be the subject of franchisor disclosure, but should properly be the subject of the same specific legal and accounting advice from each franchisee's advisers.

Recommendation 2: that the Government investigate the benefits of developing a simple online registration system for Australian franchisors, requiring them 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 Code and the Trade Practices Act 1974 (TPA)

Committee's reasoning

In rejecting the recommendations of the South Australian Parliamentary Inquiry into franchising, the Committee did not consider that registration of disclosure documents and standard form contracts was required. Further, it did not consider that vetting of such documents was viable or required, instead considering that responsibility for compliance should remain with legal advisers. However, the Committee did consider that there was merit in a simple registration system.

The system envisaged by the Committee would involve franchisors identifying the nature and size of their systems and providing a guarantee that they are operating in accordance with the Code and the TPA. The Committee considered that the features of the system and its benefits would be:

• Franchisors would not be required to lodge any of their standard documentation or provide any confidential information.

• A central government body having useful data on how many franchise systems were operating in Australia each year.

• That body would not be required to vet or store any documentation.

• Franchisors confirming each year that they were operating in accordance with the Code.

What the recommendation may mean

While this recommendation does not represent an extensive administrative burden on franchisors in terms of a requirement to actually register documents, the ramifications for franchisors, particularly in giving a guarantee, may be significant.

Prior to a franchisor providing such a guarantee, it may be incumbent, particularly on large franchise systems, for there to be an annual review to ensure compliance. Furthermore, franchisor directors may be personally liable for such guarantees if they are not correct. Overall, particularly given the potential pecuniary penalties for non-compliance, the annual guarantee will, if accepted, significantly increase the risk profile of franchisors.

Recommendation 5: that further amendments to the Code be made to require franchisors to disclose to franchisees, before a franchising agreement is entered into, what process will apply in determining end of term arrangements. That process should give due regard to the potential transferability of equity in the value of the business as a going concern

Committee's reasoning

The Committee noted that end of term arrangements were one of the most contentious areas of dispute in franchising.

The Committee rejected an automatic right of renewal for franchisees as well as an obligation for franchisors to show good cause for not renewing. In doing so, the Committee acknowledged that franchisors should be entitled to decline to renew franchises on their expiry.

However, the Committee stated that franchisees should receive reasonable notice from a franchisor of any decision not to renew the franchise agreement. More importantly, the Committee considered that franchisors must be more transparent regarding end of term arrangements and better manage franchisees' expectations. In doing so, the Committee considered that the pre-disclosure documentation should deal with the transfer process that will apply to equity in the value of the business as a going concern on expiration of the franchise agreement.

What the recommendation may mean

If accepted, this would require franchisors to provide greater disclosure of end of term arrangements. For example, franchisors may be required to disclose:

• Any regular practice in regards to renewal (ie the franchisor should disclose if it generally terminates its franchise agreements at the end of the term).

• With whom goodwill in the business will reside or how this will be transferred.

More worrying is the inherent implication in the Committee's statements that all franchisees will have some 'equity interest' in a franchise notwithstanding its expiry. It is difficult to foresee what ramifications will flow for franchisees if this recommendation is accepted.

TERMINATION RIGHT FOR FRANCHISEES?

Recommendation 4: that the government explore avenues to better balance the rights and liabilities of franchisees and franchisors in the event of franchisor failure

Committee's reasoning

The Committee acknowledged the current deficiency in the Code dealing with franchisees' rights of termination, particularly in light of the recent failures in the Australian franchising industry. Although section 18(2)(g) of the Code requires franchisors to disclose to franchisees notice of insolvency events, this does not of itself terminate the franchise agreement or amount to a repudiation of it. The consequences of such events may be detrimental to franchisees who might be required to continue to comply with their obligations (including, for example, the payment of royalties) even though the franchisor may no longer be complying with its obligations under the franchise agreements.

What the recommendation may mean

Although not explicitly recommended, this recommendation may see the introduction of a franchisee's right to terminate a franchise agreement in the case of 'franchisor failure'. Again, it is not clear what 'franchisor failure' encapsulates or what the triggers will be permitting franchisees to terminate.

MEDIATION

Recommendation 6: that the name of the Office of the Mediation Adviser (OMA) be changed to the Office of the Franchising Mediation Adviser and that the Franchising Code of Conduct be amended to reflect this change

Committee's reasoning

In its submissions to the Senate Inquiry, the Australian Competition and Consumer Commission (ACCC) asserted that there is a lack of understanding of the OMA's responsibilities with respect to franchising and suggested that consideration be given to changing the OMA's title. The ACCC submitted, and the Committee accepted, that the name change would make the OMA's role in the franchising sector more readily apparent to franchisees and franchisors seeking assistance in dispute resolution.

What the recommendation may mean

This recommendation is unlikely to have any real affect on whether the parties to a franchise agreement are aware of the OMA or that office under a different name. This will still depend on the parties reading the Code and the franchise agreement. In our view, whilst not having a negative impact, a more descriptive title for the OMA is merely an attempt at a band-aid solution to mediation in the franchise industry and is unlikely to assist.

Of course, whether that name change assists in increasing the number of franchisee and franchisor referrals to mediation with the OMA is an issue which should be monitored in the future.

Recommendation 7: that the Government require the Australian Bureau of Statistics (ABS) to develop mechanisms for collecting and publishing relevant statistics on the franchising sector

Committee's reasoning

The Committee recognised that the OMA is only one avenue for dispute resolution and that it is difficult to assess the efficacy of the current mediation provisions in the Code in the absence of a reliable understanding of the true extent of disputation in the sector. The Committee's view is that the ABS focus on franchise disputation and dispute-related franchisee turnover, using information collected from both franchisees and franchisors.

In reaching this recommendation, the Committee considered mediation in franchising. Overall, the Committee did not consider it was necessary to change the existing franchising dispute resolution procedures under the Code. In particular, the Committee did not support the introduction of new mechanisms to overcome the perceived problem of parties approaching mediation uncooperatively. The Committee did not like the concept of a tribunal sitting between mediation and the courts as they considered it added another layer of complexity, expense and constitutional uncertainty over how binding the tribunal's decisions would be.

The Committee's view was that many of the issues which lead to franchising disputes, and therefore the need for mediation, may be mitigated by the introduction of an explicit obligation in the Code for parties to a franchise agreement to act in good faith. This would apply more broadly than a simple requirement to approach mediation in good faith. Our comments on the recommendation of a good faith standard are below.

What the recommendation may mean

The collection of further information and statistics will be beneficial for all parties, particularly for franchisors if it enables them to better assess the efficacy of the current mediation processes in the Code.

OVERARCHING STANDARD OF GOOD FAITH

Recommendation 8: that the following new clause be inserted in the Franchising Code of Conduct:

Committee's reasoning

The Committee expressed the view that there is concern in the franchise sector about the absence of an explicit overarching good faith standard of conduct for parties to a franchise agreement. The recommended explicit good faith obligation underpins virtually all the other recommendations made by the Committee. The Committee made it clear that an explicit good faith obligation is likely to curb opportunistic conduct, abuse of power, improve dispute resolution and even benefit contemplated 'good will/equity value' payments as part of end of term arrangements.

The Committee's 165 page report creates the impression that imposing an explicit good faith overarching standard of conduct will serve as a magic wand to cure all the perceived franchise ills.

What the recommendation may mean

If accepted, an explicit good faith obligation will introduce further uncertainty in franchise relationships and subject a party's rights to contract on terms of their choice to subjective standards. The potential is to foster a breeding ground for increased disputes.

Further, it is unclear how this obligation would interact with the obligation to act in good faith which has been recognised by many of the state courts (but which has not yet been endorsed at High Court level).

The obligation could give rise to an increasing number of disputes and give unreasonable expectations to the majority of franchisees - leading them to believe that they are now protected by an obligation of good faith. This may lead to franchisees paying less attention to conducting comprehensive pre-contractual enquiries, obtaining independent professional advice, due diligence, the disclosure document and the franchise agreement.

PECUNIARY PENALTIES AND INCREASED ACCC POWERS

Recommendation 9: that the Trade Practices Act 1974 be amended to include pecuniary penalties for breaches of the Franchising Code of Conduct

Committee's reasoning

The ACCC highlighted to the Committee:

The ACCC indicated to the Committee that the introduction of pecuniary penalties for breaches of the Code would provide a useful deterrent to those who might otherwise fail to observe the conduct requirements imposed by the Code. The ACCC also indicated to the Committee that the proposed introduction of such penalties is consistent with the recent Productivity Commission recommendation for the introduction of civil pecuniary penalties under Part V of the Act. The proposed introduction is also consistent with the recommendation of the South Australian Parliamentary Inquiry and the West Australian Inquiry.

The Committee stated that the implementation of such penalties would also in part address concerns that the Code and/or the ACCC is 'toothless'.

What the recommendation may mean

At face value, if accepted, franchisors might face stiff penalties for non-compliance with the Code. However, the wider implication of this recommendation is that, if accepted, noncompliance with franchising regulation will attract a higher level of penalty than any other industry. Particularly given the current economic backdrop, this is not desirable or acceptable for the industry.

Further, as stated in our original submission to the Inquiry (and we were interviewed by members of the Inquiry), the interpretation of many areas of the Code still remain uncertain. Before pecuniary penalties are enacted, the Federal Government needs to amend the Code to clarify the ambiguous clauses.

Recommendation 10: that consideration be given to amending the Trade Practices Act 1974 to provide for pecuniary penalties in relation to breaches of section 51AC, section 52, and the other mandatory industry codes under section 51AD [our emphasis added]

Committee's reasoning

The Committee recognised that the Recommendation 9 amendment may also be desirable for other mandatory industry codes operating under the TPA and section 51AC breaches (unconscionable conduct) and section 52 breaches (misleading and deceptive conduct). However, the Committee noted that these changes would have ramifications and applications beyond the franchising sector and therefore were beyond the scope of the current Inquiry.

As a result, the Committee could not directly recommend their enactment but only recommend that consideration be given to amending the TPA.

What the recommendation may mean

This recommendation has wider implications for compliance with the TPA generally.

Recommendation 11: that the ACCC be given the power to investigate when it receives credible information indicating that a party to a franchising agreement, or agreements, may be engaging in conduct contrary to their obligations under the Franchising Code of Conduct

Committee's reasoning

In accepting the submissions of the ACCC, the Committee noted that the ACCC described this power as 'being able to undertake risk-based audits' and would entail examination of disclosure documents and other material being circulated by a franchisor, as well as speaking with franchisees to discern any pattern of conduct.

What the recommendation may mean

It is possible that such 'risk-based audits' could be used when there is not sufficient evidence that would otherwise give the ACCC a basis for using its existing formal investigative powers.

The issue that this recommendation raises is what does the term 'credible information' mean? Does it mean that a simple complaint by a franchisee is enough for the ACCC to commence investigations? Does this information need to be corroborated by more than one franchisee? What objective evidence would be required to make the information 'credible'?

These issues need to be resolved prior to acceptance of this recommendation.

FURTHER REVIEW

Recommendation 3: the efficacy of the March 2008 amendments to the disclosure obligations of franchisors under the Code be reviewed in two years time

Committee's reasoning

This recommendation of the Committee was in the context that a number of submissions made to this Inquiry in relation to disclosure may well already be addressed by the changes enacted in March 2008. Accordingly, the Committee was of the opinion that the efficacy of the amendments in addressing these concerns be reviewed after they have been in operation for two years.

What the recommendation may mean

If accepted, the Code will be subject to a further review in 2010.

While there is merit in ensuring that the Code is in working order, a further review will equate to three reviews of the Code within four years. The continuing uncertainty and burden on the industry will not create a stable environment, particularly when considering the current economic backdrop. Perhaps this recommendation calls into question more the timing of this Inquiry than the further review.

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