Global Trends in Franchise Regulation and the Australian Experience: Lessons for New Zealand.

Andrew Terry School of Business Law and Taxation Australian School of Business UNSW
Franchise Law Reform Symposium New Zealand Governance Conference University of Auckland 25 June 2009
1

The Regulatory Debate

The increasing influence of franchising has been accompanied by an increasingly vigorous international debate as to the regulatory environment for franchising.

Does an effective legal environment for franchising require a regulatory regime dedicated to the franchising sector?

In a perfect world we would not have franchising at all because I think they are all nonsense
J R Rau MP Member of the Economic and Finance Committee of the Parliament of South Australia, Franchising Inquiry, Hansard, 10 October 2007

The Regulatory Issues

Franchises are not ordinary commercial contracts. These were not ordinary commercial contracts but contracts giving rise to long term mutual obligations in pursuance of what amounted in substance to a joint venture and therefore dependent upon coordinated action and cooperation
Privy Council in Dymocks

 Relational and standard form characteristics. The extra-legal norms which explain relational contracting are less compelling in the context of the typical business format franchise which is characterised by both an information imbalance and a power imbalance.

The Relational Dimension

the business context.
Empirical studies by Macaulay(US 1960s) / Beale and Dugdale(UK 1970s) suggest that: Detailed negotiated contacts interfere with the creation of good business relationships. Businessmen largely operate in a contractual vacuum and do not behave as classical contract theory would lead us to believe. People engaged in business often find that they do not need contract planning and contract law because of relational sanctions. Even discrete transactions take place within a setting of continuing relationships and interdependence. The value of these relationships means that all involved must work to satisfy each other. Macaulay
6

the legal context

Increasing recognition that traditional contract doctrine unsuitable for relational contracting. Law and Economics School took up challenge of adopting modern Contract Law to commercial reality (Macneil 1978, Goetz and Scott 1981, Hadfield 1990) Relational contract theory developed to explain adequately the nature and function ofrelational contracts and how they differ from more standard contacts. (Goetz and Scott)

Contractual Analysis
Traditional Classical Contract Theory Relational Contract Theory

Important terms of the contract are reduced to welldefined obligations which are interpreted and enforced without reference to associated but external legal norms

Obligations arise not only from written document but from the norms of the ongoing relationship which supplement the written terms

Delivers predictability and certainty albeit at cost of disregarding legitimate business expectations

Parties should be accorded reasonable security for the protection of justified expectations
8

What is a relational contract?

the existence of a business relationship between the parties and the need to maintain that relationship the difficulty of reducing important terms to well defined obligations the impossibility of foretelling all the events which may impinge upon the contract the need to adjust the relationship over time to provide for unforeseen factors or contingencies which cannot readily be provided for in advance the commitment, likely to be extensive, which one party must make to the other, including significant investment; incomplete in failing to allocate, or allocate optimally, the risk between the parties in the event of certain future contingencies.

Relational Factors:
relationship (rather than mere exchange or transaction) continuing and long term interdependence cooperation communication mutual trust/confidence respect flexibility reliance highly interactive
10

 A relational contract is one which involves not merely an exchange but a relationship between the contractual parties. The parties are not strangers in the accepted sense and much of their interaction takes place off the contract requiring a deliberate measure of communication, co-operation, and predictable performance based on mutual trust and confidence. Expectations of loyalty and interdependence mark the formation of the contract and become the basis for the rational economic planning of the parties.
Thomas J, dissenting, in Bobux Marketing Limited v Raynor Marketing Limited [2002] 1 NZLR 506, 516 (Court of Appeal) adopted by Bolland J in Gough & Gilmour Holdings Pty Limited v Caterpillar of Australia Limited (No 11) [2002] NSW IR Comm 354 (NSW Industrial Commission)

11

Is Franchising a Relational Contract?

Franchising presents as the archetypal example of a relational contract. It exists in a world of contractual incompleteness and relational complexity in which the parties are not strangers; much of their interaction takes place off the contract, mediated not by visible terms enforceable by a court, but by a particular balance of cooperation and coercion, communication and strategy
Hadfield

12

Consequences of relational categorisation

controversial

contractual obligations are often modified, supplemented or completely overridden by the norms of the on-going relationship
doctrinal tool relied upon to bring the resolution of franchise disputes in line with realities of the franchise relationship is invariably the implied term of good faith. The norms of the ongoing relationship, of necessity, tend to supplement the express contractual obligations. Good faith is required to ensure that the requisite communication, co-operation and predictable performance occurs for the advantage of both parties. In short, the obligation seeks to hold the parties, to the promise implicit in a continuing, relational commercial transaction.
Thomas J in Bobux

a work in progress regulation necessary to free parties from the dubious mercy of classical bi-lateral contract law (Hammond J in Dymocks) 13

The Standard Form Dimension

information imbalance power imbalance

14

The Regulatory Challenge

Entrepreneurship and business creation in a free society
necessarily includes an element of risk and it should certainly not be the role of Government to remove risk. Nevertheless in particular circumstances of franchising there are elements quite different to normal business development because of the control of the franchisor which can be an overriding risk for the other than purely business or commercial reasons. Those special additional risks arising in part because of the balance of power in the franchising relationship should be minimised while leaving the commercial risks and decision to be handled by the parties concerned
Council of Small Business Organisations in Australia, Submission on First Exposure Draft of 1986 Franchise Agreements Bill
15

 franchising is a unique and proven model for business development entrepreneurship involves risk not the role of government to remove risk But in the particular circumstances of franchising: Are there elements quite different to normal business development because of the control of the franchisor which can be an overriding risk for other than purely business or commercial reasons? How can these additional risks be minimised while leaving the commercial risks to be handled by the parties?

16

The Regulatory Strategies

Registration

Prior disclosure
Regulating conduct in the relationship

Dispute resolution

17

Registration
from full audit to mere filing/recording

applies in various jurisdictions to either franchisor, franchisee, franchise contract, or franchise activities
annual reporting requirement common

disadvantage of imprimatur of competence

advantage of statistical data base annual filing of disclosure document?

18

Prior disclosure
No law can, or should, act to prevent the holding or seeking of high aspirations, however unlikely to be satisfied. However, it has been a long standing philosophy of free enterprise government that it is a legitimate role of government to provide, or cause by law to be provided, an accurate informational framework within which individual aspirations are formulated . Trade Practices Consultative Committee 1979

adresses the information imbalance facilitates due diligence UNIDROIT Model Disclosure Law 2002 wide acceptance uncontroversial not a restriction on business but a common sense and firm basis for doing business within the peculiarly close relationship of a franchise and in accordance with normal business practice. extent/degree of disclosure contentious compliance costs
19

Regulating conduct in the relationship

more controversial fairness and allocation of risk in entrepreneurial activity encroachment of freedom of contract uneven acceptance no universal precedent function of disclosure to warn of unduly onerous obligations variety of approaches
prescribed rights and obligations general standards of conduct specific standards of conduct
20

Dispute resolution
generally required to be addressed in agreement or via prior disclosure mediation process as prerequisite to litigation or arbitration except in limited circumstances

21

The international regulatory experience

of Practice adopted by national franchise associations voluntary self-regulatory Codes

franchise specific regulation

Mandatory regulation by law

22

The regulated sectors internationally

Albania 1994 1998 1975 Australia Barbados Korea (South) Kyrgyzstan Lithuania Macau, China SAR Malaysia Mexico Moldova Romania Russia Saudi Arabia Spain Sweden Ukraine Taiwan USA federal state Venezuela Vietnam Unidroit Model Law 1979 1970 1992 2006 2002
23

1997 1998 2000 2000 1998 2001 1997 1997 1996 1992 1996 2006 2004 1999

Belarus
Belgium Brazil Canada Model Law

1998
2006 1994 2005

Alberta
Ontario New Brunswick PEI China

1980
2001 2007 2007 1997

Croatia
Estonia France Georgia Indonesia Italy Japan Kazakhstan

2003
2002 1991 1997 1997 2004 1983 2002

Note: Year is of first franchise regulation. Note: Little uniformity in nature, extent, scope and comprehensiveness of regulation

The regulatory models

Disclosure Belgium Brazil Disclosure & Registration Indonesia Mexico Spain Disclosure, Registration & Conduct China Macau Disclosure & Conduct Albania Canadian provinces Georgia Italy Romania Malaysia Moldova Vietnam Disclosure, Conduct & Dispute Resolution Australia Korea
24

France Japan
Sweden Taiwan

Registration Croatia Barbados

Registration & Conduct Belarus Kazakhstan Kyrgyzstan Saudi Arabia

Conduct Estonia Lithuania Russia Ukraine Venezuela

USA Disclosure: Conduct: Registration: federal federal (auto/petrol) and most states (general, sector or issue specific) state (14 states)

25

The regulatory experience in Asia

regimes Australia China Korea Malaysia Vietnam minimalist regulatory regimes Indonesia Japan Kazakhstan Kyrgyzstan Macau SAR Russia Saudi Arabia Taiwan

sector self regulation Hong Kong India New Zealand Philippines Singapore

regulation imminent? India New Zealand

26

Registration
Australia China Korea Malaysia Vietnam

registration requirement
filing/recording on submission of documentation audit and registration annual reporting

27

Prior disclosure
Australia franchisee prior disclosure China Korea Malaysia Vietnam

franchisor prior disclosure

franchisor continuing disclosure days pre contract / payment prescribed disclosure document warning/advice to franchisee

14

30

10

15

28

Prior disclosure items

contract issues reference to / summary of key contract obligations non contract issues franchisor information / experience / litigation start-up costs general sector information existing franchise network non-renewals / terminations / transfers / buy-backs, ceasing operation earnings claims franchisor financial statements

Australia

China

Korea

Malaysia

Vietnam

material litigation and arbitration

termination

justify if given

justify if given
29

Conduct
Australia general standards of conduct termination China Korea Malaysia best business practice Vietnam

good faith

good faith

notice

term / renewal transfer franchisee right to associate prohibition of general release of liability marketing funds copy of associated lease

term (3 years minimum)

renewal (notice of non renewal)

confidentiality

duties consolidated Unilateral amendment

confidentiality post termination restraints conduct not reasonable to protect legitimate business interests

duties consolidated

other

30

Franchise agreement
Australia Mandatory content * China Korea Malaysia Vietnam

Cooling off
Certification re independent advice

* prior disclosure of specific contractual obligation

31

Dispute resolution
Australia Mediation as prerequisite to litigation / arbitration China Korea Malaysia Vietnam

32

Other pre-conditions to franchising

Australia none China Korea Malaysia Vietnam

two stores/one year

operation for one year general discretion to refuse registration

33

The international experience

increasing recognition that in the special circumstances of franchising there are elements sufficiently different to normal business development to justify regulation clear trend to regulation no consistent regulatory strategy no consistency within a particular strategy prior disclosure laws widely adopted no meaningful franchisor constituency for not supporting presale disclosure Unidroit Model Law symbolic almost universal acceptance little uniformity in extent of disclosure conduct laws increasingly common and surprisingly uncontroversial registration laws most common in developing sectors (US the exception) no horror stories no standard form template for regulation policy objectives in developing economies 34

The Australian Regulatory Experience

The Australian regime is draconian, too wide ranging in its application, costly in terms of compliance and often ineffective in terms of providing relevant protection to franchisees and potential franchisees.
FANZ, ORFR para 19

35

The new Australian regulation makes Australia the least desirable destination in the world for franchise systems . [Franchisors] should avoid Australia until they have nowhere else to go and even then it would be a close call.
Martin Mendelsohn 1999

36

Commercial laws of general application

Australian franchise sector

General regulation through legislative prohibition of misleading and unconscionable conduct

Specific regulation under Franchising Code of Conduct

General regulation through term of good faith implied at law as a necessary incident of a franchise contract
37

The Franchising Code of Conduct

mandatory prior disclosure prior disclosure document containing over 200 items of information continuing disclosure of key information no recording / vetting / registration mandatory regulation of particular conduct / relationship issues: 7 day cooling-off period freedom to associate with other franchisees prohibition on any general release of the franchisor from liability disclosure requirements regarding marketing funds freedom for the franchisee to transfer franchise restrictions on the franchisors right to terminate mandatory mediation

38

Misleading or deceptive conduct

A corporation shall not, in trade or commerce, engage in conduct that is misleading or deceptive or likely to mislead or deceive
s52 Trade Practices Act 1974 (Cth) (and state/territory equivalents)

the quiet achiever in franchise regulation liability cannot be excluded but increasingly innovative use of contractual devices to prevent misleading conduct arising or to preclude reliance cure not prevention

39

Unconscionable conduct
A

corporation must not, in trade or commerceengage in conduct that is in all the circumstances, unconscionable
s51AC(1) Trade Practices Act 1974 (Cth)

a more liberal unconscionability regime freed from the limitations of the equitable doctrine unconscionability not defined but determined having regard to the discretionary unconscionability factors.

40

The discretionary unconscionability factors

The relative strengths of the parties bargaining positions Whether conditions not reasonably necessary for the protection of the legitimate interests of the stronger party were imposed Whether the weaker party was able to understand relevant documents Whether undue influence or pressure, or any unfair tactics, were used Whether and on what terms equivalent goods or services could have been acquired from or supplied to other persons Whether the stronger parties conduct was consistent with its conduct in similar transactions The requirements of any applicable industry code The requirements of any other industry code if there was a reasonable belief that it would be complied with Whether the stronger party unreasonably failed to advise of intended conduct that could have a detrimental affect Whether there was a contractual right to vary unilaterally a term or condition of the contract The extent to which the stronger party was willing to negotiate contract terms The extent to which the parties acted in good faith
41

ACCC v Simply No Knead (Franchising) Pty Ltd (2000) FCA 1365

The operation of the franchise depended on the supply of products from the franchisor and group advertising for the franchise as a whole. The allegation of unconscionable conduct was based on the following conduct: Refusing to deliver franchise system products to franchisees. Refusing to negotiate with franchisees and to discuss matters of concern to franchisees. Deleting franchisees telephone numbers from Telstras 013 Telephone Directory Assistance Service without consent or the knowledge of the franchisees. Producing and distributing advertising and promotional material which omitted the names of the franchisees and their franchised businesses. Selling and offering to sell its products in the territories of the franchisees and in areas proximate to their territories; and Refusing to provide current disclosure documents to franchisees in response to written requests
42

Having regard to the discretionary unconscionability criteria and the circumstances of the case, the franchisors behaviour disclosed an overwhelming case of unreasonable, unfair, bullying and thuggish behaviour in relation to each franchisee that amounts to unconscionable conduct by SNK for the purpose of s51AC
Sunberg J

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s51AC and the franchise sector

potential application to a range of circumstances at all stages in the relationship little judicial guidance as few actions litigated limited to extreme conduct which can be seen in accordance with the ordinary concepts of mankind to be so against conscience that a court should intervene good conscience does not require parties to contractual negotiations to forfeit their advantages or neglect their own interest-that is the stuff of ordinary commercial dealings distinction between adopting an opportunistic approach to strike a hard bargain and acting unconscionably

44

Senate Standing Committee on Economics, The need, scope and content of a definition of unconscionable conduct for the purposes of Part IVA Trade Practices Act 1974, December 2008 s51AC has fallen short of its legislative intent addresses unconscionable conduct in the process of contracting rather than in the substantive bargain struck regulator and courts have not pursued critical test cases lack of clarity and guidance statutory definition not recommended replacing unconscionable with unfair not recommended target particular instances to clarify unconscionability franchise sector should produce list of clear examples of unconscionable conduct

45

Consultation on Draft Provisions of Unfair Contract Terms, May 2009

an unfair term of a standard form contract is void power to prohibit terms considered to be unfair a term is unfair if it
would cause significant imbalance in the parties rights and obligations is not reasonably necessary to protect legitimate interests

considerations the court must take into account specified B2B transactions including franchising included negotiation removes a transaction from the scope of the provisions
46

Good faith
implied in fact on an ad hoc basis based on the presumed intention of the parties implied in law as legal incident of the relationship wide, allbeit not unanimous, support The precise boundaries of the standard have evaded the grasp of precise judicial statement
Jobern [2007] FCA

47

Meaning of good faith uncertain

the antithesis of bad faith honesty fairness absence of opportunistic conduct/extraneous or ulterior purposes legitimate interests reasonable expectations community standards reasonableness
48

Limitations
inconsistent contract provisions exclusion? independent source of obligations?

49

2008 Federal Opportunity not Opportunism report

notes concerns because of the continuing absence of an efficient overarching standard of conduct for parties entering a franchise agreement

recommendation for a new clause in FCC: Franchisors, franchisees and prospective franchisees shall act in good faith in relation to all aspects of the franchise agreement

50

The concept of good faith has gained traction as the solution to all real and imagined ills within the franchising sector. For those agitating for reform it has assumed symbolic significance and, if introduced, would be argued to accommodate circumstances beyond any appropriate sphere of influence. Good faith is a seductive concept for franchisees and for the franchise regulators but it will not be interpreted by the courts to provide the universal solvent the knights of good faith seek. The Aussie mantra of a fair go is a beautiful thing but the operation of good faith will be interpreted much more narrowly. The perception that good faith is the universal solution is both misleading and dangerous, but is given life by the equating of good faith with ethics. A principle of good faith must presumably accord with ethical standards and community values, but this is not, and should not be, a concept the content of which is defined by them. While an understanding of good faith as requiring a fair go would be enthusiastically received as a panacea for both the real and imagined ills of the sector, the reality of good faith as a legal concept is quite different. If franchisor opportunism is a problem warranting legislative intervention this should be addressed by carefully crafted legislative responses rather than by defaulting to an undefined and overarching standard of indeterminate scope and application.
Terry and Di Lernia, Franchising and the Quest for the Holy Grail: good faith or good intentions? 2009 Melbourne University Law Review, forthcoming
51

NZ perceptions of Australian regime

FANZ
draconian too wide ranging in application too costly in terms of compliance often ineffective in providing relevant protection to franchisees and potential franchisees

52

Minister Simon Power

numerous inquiries and reviews resulting in several amendments
creating onerous and complex disclosure requirements leading to increasing compliance costs for franchisors and information overload for franchisees (para 24)

small number of franchising complaints to ACCC with concerns often arising due to a failure to take proper precautions prior to entering the contract (ACCC) (para 25)
unrealistic expectations (DIISR)(para 26) significant lobbying pressure to amend the Code (para 26) regulatory uncertainty for franchisors (para 26)
53

Other
the wording of the code has caused many headaches regulation encourages disputation

54

draconian
Our members believe the Code has had a beneficial effect on the franchising sector. There is overwhelming support for the existence of a Code and the franchise sector does not seek to revise the Code from a policy perspective. Franchise Council of Australia

At a time when most businesses are seeking a lessening of the regulatory burden imposed by government, the franchising industry has been prepared to accept regulatory measures to protect the image and credibility of the industry.

The Franchising Policy Council is of the view that the Code has been a successful initiative for small business in Australia. There is strong support from most participants in the franchising industry for the mandatory Franchising Code of Conduct Franchise Policy Council

55

too wide ranging in application

There is a significant amount of debate about how to define a franchise. Legal definitions of a franchise in countries that have introduced legislation have been criticised for being too narrow, allowing people to structure their business to avoid regulation, or too wide, capturing businesses which are not franchises. (para 5) . a risk arises that any definition would either be too narrow, allowing people to structure their business so as to avoid legislative requirements, or too wide, capturing business structures that are not franchises. (para 34) the definition used in Australia has been criticised as being too broad, capturing a wide range of business structures and creating uncertainty for other businesses who are unsure whether they have to comply with the Code or not. (para 35) 20% of *US franchise lawyer Rupert Barkoffs] work as a franchise practitioner is in advising clients on how to design their business model so that it did not fall under the definition of franchise. (para 35)
56

 Code definition incorporates: brand system or marketing plan payment specific inclusions/exclusions franchising v licensing/distributorships ACCC v Kyloe [2007] FCA clarify the relationships to be regulated and draft the definition little scope for contracting around the definition business dependency as a key element

57

too costly in terms of compliance

regulation imposes an initial and ongoing financial and administrative burden FANZ Code disclosure obligations impose compliance costs the Australian experience

58

Regulation originally impacted on sector growth Franchise systems 693 708 700 850 960 1,100 Outlets 38,500 41,000 44,000 50,600 61,850 71,400

1998 1999 2002 2004 2006 2008

But: exit/discouragement of inappropriate franchisors encouragement of new franchisees presumption of strong and sustained growth

59

Often ineffective in terms of providing relevant protection to franchisees and potential franchisees
The overwhelming success of franchising has attracted a number of unscrupulous operators looking to capitalise on the rapid growth in the sector, by deceiving potential small business owners with offers of bogus or unworkable franchising opportunities. The ACCC enforcement actions have been successful in discouraging these operators and it may be observed that the introduction of the Code and its administration by the ACCC has dissuaded a large number of illegitimate and dubious franchise systems from operating in Australia
ACCC
60

Onerous and complex disclosure requirements increased compliance costs information overload for franchisees

61

Small number of franchising complaints arising, primarily, from failure to take proper precautions

62

Franchising Complaints to ACCC

Franchising Council of Australia Legal Symposium ACCC report card on franchising issues John Martin, Commissioner 11 October 2007, Melbourne 63

Breakdown of the ACCC investigated franchising complaints outcomes 2006/2007

Resolution No breach Insufficient evidence Referred to other agency Guidance / information provided Administrative resolution No action Active investigations Total Number 11 12 2 24 1 3 53 106 ACCC

64

Three main categories of franchising disputes

It is the ACCC experience that franchising complaints usually allege problems in at least one of two areas under the Trade Practices Act 1974
unconscionable conduct in business transactions; and misleading and deceptive conduct/misrepresentations or disputes around the terms of franchising agreement

These concerns generally fall into three broad categories: scams, frauds or outright exploitation; issues arising from structural market pressures; and/or poor relationship management
ACCC

65

 The most challenging complaints to deal with for the ACCC are allegations and disputes resulting from the remaining two categories structural and/or poor relationship management issues. These generally manifest as persistent complaints of unconscionable conduct, harassment and coercion and/or misleading and deceptive conduct and present as a complex web of interlinking accusations and claims, requiring time consuming investigations to untangle. However, despite the painstaking analysis these matters rarely uncover breaches of the Code or the Act.
ACCC
66

 unrealistic expectations

67

constant review and regulatory uncertainty

Code will need to remain dynamic and subject to review as the franchising sector evolves.
Opportunity not opportunism report

Franchising Code of Conduct Options Paper released for industry consultation on 21 June 2009

68

Opportunity not opportunism recommendations Disclosure Clear statement of liability/consequences to franchisees in event of franchisor failure process that applies in determining end of term arrangements having due regard to the potential transferability of equity in the value of the business as a going concern
69

Registration Simple online registration system requiring franchisors to lodge statement

Confirming nature and extent of franchise network annually Providing guarantee of meeting obligations under the Code and TPA

70

Standards Franchising parties to act in good faith in relation to all aspects of a franchise agreement Government to explore avenues to better balance rights and liabilities of franchisors and franchisees in event of franchisor failure

71

Enforcement Pecuniary penalties for Code breaches Pecuniary penalties for TPA unconscionability and misleading conduct breaches Broader ACCC powers to investigate when it receives credible information indicating that a franchising party may be engaging in conduct contrary to Code obligations
72

The wording of the Australian Code has caused many headaches

Code was drafted in haste and secrecy

73

regulation encourages disputation

74

The Australian perception of the Australian experience

the Australian experience with regulation is overwhelmingly positive:
wide sector acceptance discouragement of scam merchant franchisors greater confidence among prospective franchisees greater certainty (eg termination/transfer) higher standards / best practice better and stronger relationships at all stages fewer disputes more effective dispute resolution management tool for franchisors increased public confidence better relationships between franchise sector and media/ government focus for sector education, research, networking catalyst for strengthening role of FCA as peak sector body change in public perception/symbolism sector development
75

Ironic that regulation imposed to discipline a sector has become a badge of pride for it a recognition that franchising is important enough to warrant its own regulatory regime

76

The New Zealand Response

Overall, I do not believe that there is a need for the introduction of franchise specific regulation at this time Hon Simon Power, 11 June 2009

Franchisees are left to the dubious mercy of the classical bilateral law of contracts Hammond J in Dymocks

77

franchising is not unique compared to other commercial relationships

difficult to argue that franchising is unique enough from other types of businesses and contracts to necessitate specific regulation (para 70)

FANZ favours the status quo as it does not think that there are any particular features of franchise contractswhich necessitate franchise specific regulation (para 18)

78

But Franchising can differ from other ways of doing business as franchise contracts are both relational (leaving many aspects unspecified) and standard form (take it or leave it') contracts. This means they must be flexible but also cannot be negotiated. This results in a large amount of discretion being given to the franchisor, while the franchisee has an increased amount of uncertainty and risk. (para 4)
79

 There are several aspects of this way of doing business which differ from some other standard contractual relationships: It is an ongoing relationship, rather than a single buy and sell transaction which may typically be covered by contract law; Issues of disagreement often cannot be usefully litigated as a court case is likely to destroy an ongoing relationship, whatever the outcome; There are power imbalances in many franchise agreements and, while these exist in other contractual relationships, the fact that the franchisor controls the use of the trademark and marketing system gives rise to particular market power imbalances. This is because a franchisee's entire business may depend on the trademark and marketing system; As there are usually a number of franchisees, there can be problems of equity of treatment and there can also be difficulties when a franchisor operates outlets which may compete with franchised outlets; and Obtaining information prior to an agreement can be difficult. (para 28)
80

Franchise contracts are, to varying degrees, both relational and standard form contracts, which creates some tension. Relational contracts create continuous and long-lasting relationships. They are defined by features of incompleteness and longevity, and must be flexible. Often a high level of discretion is accorded to the parties and the contracts rely on reciprocity and trust developed over time. On the other hand, the individual terms of standard form contracts are not generally negotiated they are presented on a take it or leave it' basis. An imbalance of power results and the lack of negotiation can make it more difficult for the terms of the contract to be fully understood. The combination of these in a franchise contract gives a large amount of discretion being given to the franchisor, while the franchisee has an increased amount of uncertainty and risk. (para 29)

81

little evidence of widespread problems

there is little evidence of widespread problems within the sector. (para 70)

FANZ favours the status quo as it does not think that there are any widespread problems in the sector which necessitate franchise specific legislation. It does not believe that franchising should be singled out from other forms of business. (para 18) Contrast with Australia where a series of reports have identified problems within the sector
82

franchising development in Australia

1970s 1980s - entry of the US franchised fast food systems and adoption of the concept by local businesses - franchising emerges as a significant economic force - bad practices, bad press and increasing government scrutiny - increasing growth, bad practices and government intervention - Australian franchising sector has the greatest concentration of franchise systems per capita among the worlds major economies - a mature, highly significant, diverse and dynamic sector - includes virtually all consumer products and services - increasing influence in B2B and quasi-professional services

1980s
1990s 2000s

83

1976 1979 1986 1990 1991 1995 1995 1996 1997 1997

Swanson Report Blunt Report Franchise Agreements Bills Consultative Papers Beddall Report Franchising Task Force Report Gardini Report Better Business Conduct Discussion Paper Franchising Code Council Disputes Review Fair Trading Report New Deal: Fair Deal Statement

2006
2007 2008 2008 2008

Matthews Report (Review of the Disclosure Provisions of the FCC)

ACCC Report Card on Franchising Issues WA Report (Inquiry into the Operation of Franchise Business in WA) SA Report (Franchises: Final Report) Federal Report ( Opportunity not Opportunism: Improving conduct in Australian franchising)
84

Pre 1981 1981 - 1987

Regulation only under the general law Quasi-regulation under the prescribed interest/managed investment scheme provisions of the Corporations Law

1987 - 1993
1993 - 1996 1997 - 1998 1998 - current

Deregulation
Self-regulation under the voluntary Franchising Code of Practice Deregulation Regulation under the mandatory Franchising Code of Conduct

85

Unfair conduct by big business towards small business is [a] major concern [and] has been a matter of grave concern for many years. Not only has such conduct the potential to impact heavily on the economic health of the small business sector and on the allocation of resources generally, it can also involve heavy social cost. Australian Fair Trading Report 1997

86

current processes adequate

There is insufficient evidence to indicate that current processes are inadequate to address any issues (para 70)

Underlying laws of general application FANZ Code of Practice

87

Underlying general laws

not as comprehensive as NZ

franchise business accounts for about 10-12% of economic activity in NZ but franchisees represent about 30% of misleading conduct actions under the FTA

88

FANZ Code of Practice

FANZ Code provides strong protection 400 franchise systems in NZ with 350 active (what is an inactive system??) FANZ membership represents 40-50% of franchise systems limitation of voluntary sector self regulation
coverage consequences

Australian experience

89

perception issues
the public's confidence in the franchising sector may have been damaged following the cases of alleged fraud. Public confidence is important so that quality recruits are attracted to the sector, allowing it to continue to grow and develop. (para 13) introducing regulation to address perception issues was raised as a concern (para 16)

regulation is introduced to address information and power imbalance issues public confidence and perception issues are desirable byproducts

90

addressing the information imbalance does not solve the problem

it is unclear that current arrangements which encourage due diligence are inadequate, or the extent to which the options above would be effective in addressing information imbalances. (para 46)

There is not strong evidence to suggest that options to address information imbalances would result in better outcomes than the existing processes to encourage due diligence. (para 54)

91

Mandatory information disclosure may also be ineffective, especially in targeting vulnerable groups who may not understand or use the information that they are given. (para 49)

92

Information disclosure only relates to the formation of the contract and not its performance, where issues would usually arise. (para 50)

93

addressing contractual power imbalance - not an issue?

A second group of options relates to addressing power imbalances and the unilateral rights conferred upon franchisors under franchise contracts. This could be done by mandating for certain contractual terms to be included in franchise agreements, for example good faith' bargaining or mandatory right of renewal. (para 55)

94

addressing enhanced dispute resolution

low cost dispute resolution is a generic issue for small business and there does not appear to be anything specific about this to franchising. (para 61) it is unclear that there is a problem [with relational disputes] with current arrangements or the extent to which mandatory mediation would be effective. (para 64) Mediation is only successful if both parties cooperate and are willing to work towards a solution. Therefore, making mediation compulsory for franchise disputes may not necessarily work and could provide an opportunity to further draw out the resolution of disputes. (para 67) Some disputes would also not be suitable for mediation, such as those relating to trademarks. In some cases, parties may need interlocutory relief to act urgently and mediation would not be appropriate. (para 67)

Thus there is not a strong case for making mediation mandatory for franchising. (para 68)
95

difficulties in regulating for better understanding, proper research and due diligence
Some problems appear to be the result of a lack of education amongst franchisees and/or a failure to carry out appropriate due diligence before entering into a franchise contract. It is difficult to legislate to remedy this. (para 6)

While some see an information imbalance between franchisors and franchisees, others see a lack of understanding among franchisees and a willingness to enter contracts without doing the proper research or due diligence which lead to disputes. It is difficult to legislate to remedy this. (para 71)

96

Regulation

Education and understanding

Specialist advice

Franchise protection

Due diligence and research

Dispute resolution

97

many of the problems that can arise do not appear to be exclusively problems with franchising, but issues which can occur in commercial relationships generally. (para 42)

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risks and costs outweighs benefits

It is also likely that the risks and costs of regulation would outweigh the possible benefits. These include the small size of the sector in New Zealand which would suffer from potential compliance costs and the difficulty in defining franchise'. (para 72)

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the small size of the sector

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the dearth of red tape and low costs associated with introducing franchising to NZ makes it attractive to franchisors, particularly those from Australia

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regulation will not prevent Green Acres

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UK does not have regulation

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Regulation interferes with freedom of contract

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unclear that regulation would be the answer to any perceived problems. (para 71)

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Conclusion
Franchisees are damaged, and franchising is diminished, by the inappropriate practices of those who trade off the reputation of franchising without the ability to deliver on the promise of franchising Franchising is not an ordinary commercial contract

There are elements quite different to normal business development because of the control of the franchisor which can be an overriding risk for other than purely business or commercial reasons Regulation can address the additional franchise specific risks while leaving the commercial risks to be handled by the parties
Regulation on its own can never be a complete answer
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The experience in Australia under the mandatory Franchising Code of Conduct provides comfort to those franchising sectors facing regulation that appropriate and balanced regulation can have a beneficial effect on the franchising sector and encourage its orderly development for the benefit of all stakeholders.

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