Is the Franchising Code of Conduct working for franchisees?

By Sarah Stowe | 29 Oct 2015 View comments

Andrew Terry, Australian School of Business at UNSW, and Special Counsel, Deacons

The purpose of the Franchising Code of Conduct as set out in clause 2 is to “regulate the conduct of participants in franchising towards other participants in franchising”. There is a degree of political correctness in the stated purpose. It would be more accurate to state that its purpose is to “regulate the conduct of franchisors towards franchisees” as the CodeÕs obligations are imposed on franchisors to protect franchisees. (The compulsory mediation provisions may be argued as an exception in that both franchisor and franchisee are committed to mediation as a prerequisite to litigation. But, given the usual disparity in resources that characterise franchise relationships, mediation can be regarded as a franchisee protection initiative).

The above discussion on semantics should not be interpreted as discounting the commercial reality that in, terms of information and power, franchisees are disadvantaged or as an argument that the Code shouldnÕt protect franchisees. It was of course a consideration of these factors that led to the introduction of the Code in the first place. It is nevertheless important, in my opinion, that a debate as to the effectiveness of the Code should recognise that it represents the most comprehensive regulatory document for the protection of franchisees that exists anywhere in the world. If the extent of the franchising world can be measured by the number of countries that McDonaldÕs has a presence in (100) only about a quarter have specific franchise regulation to protect franchisees.

Many of these regulatory schemes are minimalist and provide little real protection for franchisees. Australia is the only country that provides real franchisee protection by way of comprehensive prior disclosure, conduct regulation (including transfer rights and protection from arbitrary termination) and mediation. In this context the Code is a very significant advance for franchisee protection. It confers rights in relation to its three limbs – prior disclosure, conduct and mediation – that did not exist at common law prior to the Code. So, when the Code is assessed in comparison to the law that existed prior to its introduction it is working very well for franchisees. But, ignoring history, is it really working for franchisees? In relation to what the Code does, it does it effectively and well. Existing prior disclosure, conduct and mediation obligations can be, and should be, refined but in substance they are sound.

The problem is not what the Code does as much as what it doesnÕt do or what franchisees would like it to do. It is, of course, possible for a revised Code to incorporate every item on every franchiseeÕs wish-list. It is possible to introduce mandatory renewal rights, mandate good faith obligations of uncertain application, guarantee a financial return, provide goodwill compensation to an exiting franchisee. But if such initiatives were to be introduced they would clearly change the legal and commercial nature of franchising as it is practised throughout the world and would inevitably impact on the use of franchising as a strategy for business development. Entry costs for franchisees would inevitably increase.

Small entrepreneurial systems responsible for much of the vitality and diversity in franchising would be much less likely to emerge — to the detriment of not only the business itself, and consumers, but also those aspiring business entrepreneurs who would have less opportunity to be franchisees.

Michael Marcus, The Franchisees Advocate Group

Until the Code ensures that reliable and relevant financial information is available to prospective franchisees, the good intentions behind the Code will not be achieved. This necessity is so fundamental, that one wonders how it has become lost. Prospective franchisees do not expect guaranteed financial performance.

What prospective franchisees are entitled to know before they pay up is at least the following basic information:

• what revenue/sales can I expect in each of the first three to five years?

• what are the major costs and expenses that I can expect (relative to those sales) in each of those years?

• the geographical area the information refers to.

This must not be allowed to be aggregated to the extent that it is irrelevant. If the franchiseeÕs expectation of future financial performance is created from actual and relevant financial data, many of the problems that currently arise would be avoided. This openness would also result in a more co-operative franchisee and franchisor culture taking hold throughout the industry.

The role of a regulatory body to ensure that such financial information is made available by franchisors to prospective franchisees in a stipulated format (that is simple to understand) is critical to protect prospective and current franchisees, and will result in a quantitative improvement to the Code of Conduct. This must not be allowed to become a science project. There will be many reasons given for why it canÕt work but there are many more why it can, and why it should. Information is power. The power for franchisees to make decisions based on facts, not hype. That can only be good for both franchisees and bona fide franchisors.

Steve Wright, executive director, Franchise Council of Australia

Federal MP Bernie Ripoll is fond of talking about finding a pathway to improvements in the franchising sector. The interesting questions are where Mr RipollÕs pathway will lead him? Bernie Ripoll is chair of the Federal ParliamentÕs Corporations and Financial Services committee which has decided to inquire into the state of franchising in Australia and reflect upon the Franchising Code of Conduct.

It is not clear exactly what prompted the inquiry, but Bernie Ripoll has been at pains to point out that it is not an inquiry about good faith negotiations and end-of-term compensation payouts (although the issue of good faith negotiations is explicitly mentioned in the inquiryÕs terms of reference). I believe Mr Ripoll and his colleagues are genuinely seeking ways to improve the day-to-day operations of the franchising sector and to rid it of exploitative behaviour.

This is a worthy goal and one the FCA supports, for the good of the entire sector — franchisors, franchisees and suppliers/advisers, acknowledging their fundamental interdependence in the franchising business model. The cautionary note is that they beware of introducing new regulations which have the effect of retarding growth and undermining the attractiveness of the sector to new investment. Among the many submissions to the inquiry there are a lot of claims by former franchisees of widespread exploitation by unscrupulous franchisors, of bullying and deliberate franchise churning tactics.

If this were the case, franchisors would appear to be rather witless in writing franchise agreements which run for a decade — and which are routinely rolled over into another term for the existing franchisee on the same, if not better, terms. The reality is these kinds of claims are just not accurate. As Professor Lorelle Frazer of Griffith University told the committee, churning is not rampant in the sector, in part because the Code works against it, but also because it simply does not work as a sustainable business strategy.

It is also wrong to suggest, as many submissions do, that there is a major issue for franchisees who are unable to get renewal when they reach the end of their agreements. Again, as Professor Frazer pointed out, the statistics do not support this contention.

Because there is no proof of the supposed problem, the FCA rejects the proposed remedy — the introduction of a Ôgood faith negotiationsÕ clause into the Code. It sounds okay when you say it quickly but we firmly believe the only result of such a move will be to introduce ambiguity where there presently is no ambiguity; to introduce the possibility of legal argument where there presently is no legal argument. Interestingly, the ACCC — the sector regulator and guardian of consumer rights — shares this view.

On the question of positive contributions to change, we believe there are areas of existing Code requirements that can be refined. The FCA believes constructive changes could be made in transparency of disclosure regarding end-of-term arrangements; in improvements to mediation availability and cost and in broadening the complaint mechanism beyond that which is investigated by the ACCC.

The FCA also supports any government initiatives to assist ACCC-led behaviour corrective campaigns or measures. We have already initiated our own steps with state governments and the ACCC to try to improve franchisee education, including before franchisees actually enter the sector. We would welcome any Federal Government involvement in this area, as one thing we all seem to agree upon is that education is the best remedy across the board.

Tony Melhem, chairman of the National Franchisee Forum and FCA director

Above all else, franchisees want certainty. They need to be able to formulate a business plan knowing what the terms are going to be across the life of the agreement. They do not want unknowns and they do not want to get into expensive and time consuming legal struggles. Legal battles are the antithesis of good franchising practice.

Successful franchising acknowledges interdependence, it is a marriage where the franchisor and franchisee share in success. One cannot survive without the other; profits are maximised when the relationship is harmonious. Therefore, any threat to harmony is a threat to profitability and success of the model.<

As a franchisee, I would love to have no-cost automatic agreement renewal. I would love to have a goodwill payment at the end of term but I don’t want those things if I have to pay for them upfront, through the life of the agreement or if I have to have a legal battle to get them. Because, either way, I know I will pay — and I will be totally distracted from my business while the argument is underway, and possibly afterwards as well.

The end result of disputes not settled quickly is bitterness and the sale of the business. This is not the way good franchising works. Thankfully, for the overwhelming majority, it is not their experience. Almost all franchisees who want to sign a new agreement are able to do so, usually on the same terms, sometimes on better terms. Good franchisors often reward good franchisees with some form of reduction in their payments to the system on renewal of the franchise agreement; reductions which increase the share of the profit available to the franchisee.

When I conducted a survey of franchisees in 350 systems earlier this year, not one raised goodwill or any form of end-of-term payday as an issue. Franchisees know that they have an agreement which makes it clear how they need to plan their business to maximise their sale price. If they don’t think about this before they sign the agreement, they are not doing themselves justice. If they ignore the issue until the end of their term, they are just plain naive.

The rules as they stand are clear. They are understood. I don’t believe there is a need to change them. And any move to change which adds to the uncertainty is more likely to do harm than good.